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Chicago Fed Letter
The growth of person-to-person electronic payments
by Tim McHugh, senior research analyst, Emerging Payments Studies Department

Credit cards, debit cards, and ACH have increased the share of electronic payments
both at point-of-sale locations and for bill payments. Although the adoption of electronic
payments in the consumer-to-consumer payments setting has lagged behind these other
areas, online person-to-person payment systems have recently been reporting strong
growth. This article analyzes the growth of online P2P payments, the problems and
oppor tunities faced by payment providers, and the future of electronic C2C payments.

Recent payment innovations at the point

of sale and for bill payments are showing significant increases in consumer
adoption. The National Automated
Clearing House Association (NACHA)
reports that the use of automated clearing house (ACH) services for direct payments increased by almost 20% in 2001.
Meanwhile, a recent Federal Reserve study found that
1. Online P2P payment volumes, 2001
use of electronic payments,
such as debit cards and cred( - - - - - - - percent - - - - - - - )
it cards, is growing signifiOnline auctions
cantly.1 Yet, many electronic
Small business
payment innovations have
failed to gain adoption for
Other (e.g., gambling)
(C2C) payments. In addiSOURCES : Bezard (2001), Robertson (2001), PayPal 2001 10-k Prospectus,
and author’s analysis.
tion, according to a recent
Federal Reserve study, C2C
check payments account for
11% of overall check volume and 22%
of consumer check volume.2 Cash transactions remain one of the most frequently used form of payment, and money
transfer systems continue to grow. Tower
Group estimates that nearly 33 billion
C2C payments occurred in the U.S. during 2000, the vast majority of which were
paper-based payments.3 The recent emergence of what is commonly referred to as
online person-to-person (P2P) payments
represents a potential vehicle through

which paper-based C2C payments can
be reduced. This article reviews the
emergence of online P2P payments,
their structure, business models, and
factors contributing to their success.
Here, I use “C2C transactions” to refer
to all payments that occur between two
consumers. I use “online P2P transactions” to describe transactions involving the use of e-mail to make payments
over the Internet. As figure 1 illustrates,
many online P2P transactions are actually consumer-to-business payments.
Online P2P payments

The majority of online P2P payments
occur through the following process.
The sender of the funds must either sign
up for the online P2P payment ser vice
or carry an existing account. Depending upon the P2P service, the funds may
be withdrawn from a credit card, bank
account, and/or previous balance. The
funds are then transferred to the receiver’s account, and an e-mail is sent to
the receiver. The receiver of the funds
must sign up for the service or have an
existing account. The P2P service disburses the funds out of the receiver’s account through a variety of avenues—
including an ACH payment, a check
payment, an ATM withdrawal or debit

card purchase, or a credit to a credit
card account—or retains the funds.4
Most services charge the receiver a variable fee depending on various factors,
including how the payment was funded
and credit history. The receiver might
also pay a fee to receive a check.
Given the volume of money transfers
and increased cross-border transactions
via the Internet, many systems have begun to provide international payments,
using credit card networks, checks,
and local payment clearing houses.
Differentiating among services
The primar y differences among P2P
ser vices lie in their target markets, fees,
and ownership structures (see figure 2).
Most services charge the entity receiving
the funds. However, one provider charges the sender, while another allows the
sender and receiver to negotiate fees.

Most providers actively target the online
auction market. Still, others pointedly
state they intend to focus on small businesses and money transfers. These differences may prove critical as providers
develop their pricing schemes and additional services.
Finally, the ownership structures of these
ser vices vary considerably. While most
are non-bank payment providers or ecommerce companies, some are banks.
Current usage
Much of the media attention directed
at online P2P payment networks arises
from the networks’ association with the
growth of online auctions. Thus far, the
vast majority of online P2P transactions
have taken place through online auctions (see figure 1). The use of checks to
complete transactions at eBay decreased
from about 80% in late 1999 to 50% at
the end of 2001, though the aggregate
number of checks written has increased
from 51.8 million in 1999 to 105.7 million in 2001.5 Tower Group estimates
nearly 100 million online P2P transactions in the U.S. in 2001, growing to
four billion in 2005.6
Online P2P payments versus e-money

Why have online P2P payments succeeded, while e-cash and stored value
initiatives have not? The following are

two plausible reasons: 1) P2P payments
were developed to meet a clear demand
from both consumers and merchants;
and 2) P2P providers leveraged past payment innovations and existing networks
rather than building entirely new ones.
Consumers and merchants needed a
quick, secure means of delivering payments at online auctions. P2P offered
consumers a convenient and fast means
of payment, as well as lucrative incentives.7 Furthermore, online P2P payments expand the seller’s ability to
accept credit cards without relying on
a merchant banking relationship. As
such, online P2P payments simultaneously meet the demands of both
consumers and merchants in the online auction environment.
Electronic money, on the other hand,
was developed to reduce the costs of
handling cash for merchants and banks.
However, these applications failed to
demonstrate a compelling reason for
consumers to adopt a new means of
payment. This became clear during
several high-profile tests of “smart cards”
in New York and at the Atlanta Olympics. As the tests progressed, very few
consumers continued to use the cards
after spending the promotional dollar
amount. After a 15-month run in New
York, pilot participants spent an average of $1 per month per card.8
Furthermore, online P2P providers
built their product on the shoulders
of existing payment networks. Online
P2P payments are simply traditional
payments through a more convenient,
online channel. The clearing and settling of funds takes place through traditional methods, while the P2P provider
offers an additional layer of customer
ser vice and convenience.
Past research has found that new payment innovations can overcome network
effects and the high costs of establishing a network by building off past payment infrastructure.9 For example,
signature-based debit cards overcame
several challenges by leveraging the
credit card networks. While P2P providers have made ample use of existing payment networks, stored value
and e-cash applications attempted to
build entirely new ones.

Business implications of online P2P

Fraud issues
Fraud remains a critical issue for online P2P providers, because they assume
responsibility for any chargebacks from
fraudulent transactions. In mid-2000,
a group of Russian hackers began laundering cash from stolen credit cards
using online P2P payment systems.10
Their efforts forced some P2P providers to leave the market.

Roberds (1998) has determined effective fraud rates for credit cards at 0.15%,
cash at less than 0.10%, checks at 0.02%,
and debit cards at 0.01%.11 PayPal has
reported fraud rates of around 0.66%
in 2001. However, credit card fraud
rates for Internet purchases are significantly higher—an estimated 2.50%.12
P2P providers use several different approaches to decrease fraud. Some banks
restrict the use of the ser vice to their
customers. In addition, most providers
verify customers’ bank accounts by
making small deposits to the customer’s
bank account. The customer then reports the amounts to the provider. This
method uses the banks’ security features
and confirms the identity of users. Most
providers also establish spending limits
on accounts, while monitoring them
for suspicious activity.
Revenue generation
Online P2P providers originally derived
the majority of their revenues from float.
Today, transaction fees account for the
vast majority of revenue. The typical pertransaction fee is around 2% of the transaction plus $0.30 (see figure 2). While
this fee is slightly lower than those associated with credit cards and offline
debit cards, it is significantly higher than
fees for other forms of payment, such
as PIN-based debit cards, checks, ACH,
and cash. Because these fees have only
recently been applied to a wide audience,
it is not yet clear how users will react.
Per-transaction costs
Initially, the vast majority of online P2P
payments were funded with credit cards.
Recently, this number has decreased as
several providers have implemented a
tiered pricing structured around how
the payment is funded. This issue is

2. Differentiating P2P payment systems

P2P system

Yes No






Who pays fee?
Receiver Sender




Target market
transfer business



2.2%–2.9% + $0.30
0.75%–2.5% + $0.35


Bank One










Typical domestic fees b








2.2%–2.5% + $0.30
Not disclosed
Set by individual banks

As of Q1:2002; bas of January 22, 2002.


NA indicates not available.


Company websites and author’s analysis.

critical given that an account funded
via ACH costs a provider $0.03 to $0.05.
Conversely, credit card payments typically cost a provider 1.9% of the transaction plus $0.15.13 Credit cards do
provide liquidity to some consumers
who might not other wise use these services; however, for other customers,
online P2P providers are working to
decrease the percentage of payments
funded with credit cards.
Regulatory concerns
Currently, several payment providers operate outside the jurisdiction of most
banking regulators and do not consider
themselves a bank or savings institution—though a few providers have applied for money transmitter licenses from
several states.14 However, this could
change in the future.15 Having to qualify
as banks or money transmitters and obey
the laws/regulations applicable to such
businesses might increase the costs incurred by these providers. At the same
time, this might also increase consumer confidence in these institutions.
Future of P2P payments

Electronic payment providers have had
little success with C2C payments. The
partial success experienced by e-money
initiatives is limited mainly to closed-loop
environments. Similarly, only a small
minority of online P2P payments can
be characterized as C2C. Next, I offer
three reasons why electronic payments
have failed to capture the C2C market.
First, technology limitations have hampered the adoption of electronic C2C
payments. While online P2P payments

make remote C2C transactions convenient, only about 50% of U.S. households have Internet access. An even
smaller percentage of households access
the Internet via mobile devices, making face-to-face C2C transactions—such
as splitting a bill at a restaurant—very
difficult and inconvenient.16 While the
U.S. is a leader in the adoption of computers and the Internet, it lags behind
other industrialized countries in the
adoption of mobile technology. Until
Internet access via mobile devices becomes ubiquitous and consumers feel
comfortable with the technology, it appears cash and checks will continue to
dominate face-to-face transactions.
Second, most consumers find few problems with the use of cash and checks.
Mantel and McHugh (2001) point out
that emerging forms of payment may
need to be significantly better than existing forms of payment for consumers
to switch their habits. As such, electronic C2C payment instruments may need
to exhibit significant value-added features and incentives above those offered by current payment instruments.
Third, providers of electronic C2C payments face a large obstacle in implementing fees for these transactions.
Since many consumers do not face explicit per-check fees and there is no explicit per-transaction cost to consumers
for a cash transaction, consumers are
not accustomed to paying fees for C2C
transactions. Consequently, electronic
C2C providers will find it difficult to derive significant profits from these transactions. However, some payment

providers have successfully charged
consumers for C2C
transactions. Several online P2P providers currently
charge for their
services. Yet, most
providers only
charge for consumer-to-business payments, with very
few charges for
C2C transactions.

money transfer businesses have also
been successful in implementing fees
for C2C transactions. However, these
services add two critical value-added
features. First, they vastly improve the
speed at which the funds are sent. Second, recipients without bank accounts
can send and retrieve funds from these
services. As such, these services extend
the payment system to a segment of
consumers that may not be served adequately by the existing payment infrastructure.
Lastly, the financial ser vices industry
has experienced great success at indirectly implementing fees on retail payment instruments and bundling services.
For example, by bundling the cost of
check services into their monthly fees
for accounts, some banks have indirectly passed on the cost of these services
Michael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research; Douglas
Evanoff, Vice President, financial studies; Charles
Evans, Vice President, macroeconomic policy research;
Daniel Sullivan, Vice President, microeconomic policy
research; William Testa, Vice President, regional
programs and Economics Editor; Helen O’D. Koshy,
Editor; Kathryn Moran, Associate Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago. The views expressed are the
authors’ and are not necessarily those of the
Federal Reserve Bank of Chicago or the Federal
Reserve System. Articles may be reprinted if the
source is credited and the Research Department
is provided with copies of the reprints.
Chicago Fed Letter is available without charge from
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ISSN 0895-0164

to consumers. In the case of ATMs,
banks have successfully implemented
fees for the electronic version of a previously free service (i.e., the use of bank
tellers).17 Furthermore, several banks
are bundling electronic banking and
bill payment ser vices for one fee.
As such, banks appear to be well positioned to play an active role in this market by bundling online P2P payments
with other retail services. Nonetheless,
many banks that entered this field have
stopped offering these ser vices.18







During the past two years, electronic C2C
payments have attracted the attention
of the payments and banking sectors.
The seemingly unlimited potential and
current growth rates invoke forecasts
of exponential growth for these systems.
Furthermore, electronic C2C payments
present a fertile area for a movement
away from paper-based payments.
However, limited ground has been
gained in shifting C2C transactions to
electronic form. Online P2P payments

See Federal Reserve System (2001), “Fed
announces results of study of the payments
system: First authoritative study in 20 years,”
press release, November 14.
Due to difficulty distinguishing between
consumers and small businesses, the study
was unable to classify 14.5% of the total
check volume, indicating that C2C check
volume might be over- or under-estimated.
Elizabeth Robertson (2001), “Internet opportunity? The potential of the evolving
person-to-person payment market,” Tower
Group Research, report, January.
Kenneth Kuttner and James McAndrews
(2001), “Personal on-line payments,” Economic Policy Review, Federal Reserve Bank of
New York, December, pp. 35–50.
Steve Bills (2001), “Billpoint CEO to banks:
We could use help,” American Banker,
December 14, p. 18. The total number of
checks written on eBay was calculated by assuming 50% of all listings were completed
as transactions. See also, Cheryl Wilson
(2000), “The new colors of money for online transactions,” The Red Herring, October.
See Robertson (2001). Celent forecasts
three billion email-based payments in 2001
and 37 billion in 2003. See Gwenn Bezard
(2001), “P2P goes pay anyone: An overview

of email payments,” Celent Communications,
research report, May 10. The methodology
used for these studies is not made public;
therefore, we cannot verify the accuracy of
these statistics and note that they should be
interpreted with caution.

Leo Van Hove, (2001), “The New York smart
card trial in perspective: A research note,”
International Journal of Electronic Commerce,
Vol. 5, No. 2, Winter.


See Brian Mantel and Tim McHugh (2001),
“Competition and innovation in the consumer e-payments market? Considering the
demand, supply, and public policy issues,”
Federal Reserve Bank of Chicago, Emerging
Payments, occasional working paper series,
No. EPS-2001-4, December.

In the next few decades, technology will
likely develop that will make electronic
C2C payments more accessible, convenient, and inexpensive. However, payment providers are likely to continue to
struggle to find the right combination
of fees and incentives that will drive
consumer adoption and profitability.


Ralph Wilson (2001), “Review: PayPal,” Web
Marketing Today, No. 101, July 9.


These costs are based on PayPal estimates.


The FDIC recently wrote an Advisory Letter stating that consumers’ funds held by
PayPal in non-interest-bearing accounts
were eligible for pass-through deposit insurance but declined to comment on the status
of PayPal as a bank. The New York Banking
Department has also ruled that PayPal is
not engaging in illegal banking activities,
though PayPal was encouraged to apply for
a money transmitter license.


See Kuttner and McAndrews (2001) for a


According to, there
were 19 million wireless Web users in the
U.S. in 1999. According to the International Telecommunications Union, there were
110 million mobile phone subscribers in


However, ATMs might add a level of convenience (such as not waiting in line at the
teller) that is more valuable to consumers
than the surcharge.


Deborah Bach (2002), “B of A latest to drop
plan for P-to-P payments,” American Banker,
March 12, p. 1.

PayPal initially offered consumers $10 for signing up and $10 for each referral. It has scaled
back these incentives, but Citibank now offers similar incentives for its c2it service.


have found initial success in the online
auction environment, but only a small
share of online P2P payments are actually conducted between two consumers.


Deborah Bach (2001), “PayPal’s IPO filing
strikes many as ill-timed,” American Banker,
October 2, Vol. 167, No. 189, p. 1.


William Roberds (1998), “The impact of
fraud on new methods of retail payments,”
Quarterly Review, Federal Reserve Bank of Atlanta, First Quarter, pp. 42–52.

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102