Why The Big Banks Created Zelle

I almost never carry cash, only my credit cards. And I pay my bills to my friends using this. Honestly, this has changed the world and the way money moves in the economy. An estimated 149 million Americans, or 62% of smartphone users, use peer-to-peer payment services. That's up from 90 million people in 2019. Shares of payment services like PayPal, which owns Venmo, and Block, which owns Cash App, soared in 2020 as more people began sending money digitally. And then there's Zelle, which launched in 2017 and is owned by seven big

banks

. It stands out from its competitors in one important way: it doesn't have a standalone revenue stream.

Zelle is a consortium of

banks

working together for an opportunity and not as an independent company. Financial institutions that offered P2P services, many of them, got together and decided they needed a common brand. But customers who use any P2P service are vulnerable to being scammed. What are the costs to consumers when things go wrong in payments? So why did banks create Zelle? And what can be done to stop fraud on the platform? Zelle was launched in early 2017. It is owned and operated by Early Alert Services LLC. That company is co-owned by seven major banks: Bank of America, Truist, Capital One, JPMorgan Chase, PNC Bank, U.S.

Bank. Bank and Wells Fargo. There are more than 1,800 banks and credit unions participating in the Zelle Network. Zelle is a P2P payment system that allows two people with different bank accounts to send money from one bank account to another instantly. They are trying to create the ease of money transmission that Cash App, PayPal and Venmo have, but doing so in an ecosystem contained within the bank. And banks needed a service that anyone could use because you, your mom, and your best friend could sign up for Venmo, Cash App, or PayPal and send money to each other, while you might not be able to do it directly from your bank account. .

The banks didn't want to lose that commitment, so they said: Let's create a service that is open to everyone. Projections suggest that Zelle will surpass Venmo, PayPal, and Cash App in transaction value in 2022. You should think of this as an adaptation of sorts, but also as an engagement tool rather than a revenue-generating machine. Peer-to-peer payment applications date back to the late 1990s, with the founding of PayPal. When eBay was basically a baby. It was a wonderful invention that happened right after the year 2000. So it made it easier to transact between people who didn't know each other, particularly in this online auction space.

And at that time we were still using checks for those types of transactions. That's what peer-to-peer payments attempted to address. And PayPal was the peer-to-peer payments provider that stepped in to make it happen. Several banks tried to compete with PayPal in the early 2000s, but were eventually forced to close. One of their main flaws was trying to monetize their services when PayPal was not only free, but also paid people to join and refer friends. I think the failure in the past was that they were trying to emulate PayPal without really understanding what was going on. They were trying to monetize something that was already being given away.

So, they've obviously learned that lesson because Zelle is a free P2P mechanism. The other thing that led banks to back out of P2P payments was the high rate of fraudulent activity. With the start of any new product or service, there is fraud and gaming, and the important thing is how quickly you can learn and consume that to improve the product. It has a real impact on how well the service can survive. And it's true that financial institutions' tolerance for this kind of thing is quite low, while a fintech might be more willing to take some losses and learn as they go.

Venmo was founded in 2009. PayPal bought it in 2013 and gained popularity a few years later. Similarly, Cash App was launched in 2013. For banks, it's a no-brainer to try to compete in that space. Customers use their mobile banking apps all the time and no one wants to see the opportunity from a space where people are already very active towards competing third parties. So that's where Zelle came into the picture. So, Venmo is quite different from Zelle. At first glance, it is also a rival to account-to-account fintech. But there are several different ways Venmo can monetize its consumer base that Zelle doesn't take advantage of for a variety of reasons.

Venmo has the most users but smaller volume. That leads to a lower average transaction value. Zelle, on the other hand, has a really high average transaction value. This is because it is very popular for high value transactions. For example, I use Venmo a lot for social activities, but I also pay rent on Zelle. And that dichotomy is very common and makes the competition in this space really interesting because it's not necessarily a "winnable space." It's a space where providers can compete for volume, but they can compete for different types of volume. And you can get users who are on another platform to use yours, even if they don't leave the one they used before.

Strict security can be at odds with convenience, and that also applies to P2P payment apps. Of the seven banks that own Zelle, four of them reported more than $90 million in scam or fraud claims in 2020. That figure jumped to nearly $236 million in 2021. An October 2022 Senate report projects it will surpass $255 million in 2022. It is also said that in most cases banks do not refund customers who were victims of fraud or scam. You built the system, you profit from every transaction in the system, and you tell people it's safe. But when someone is defrauded, you claim it's the customer's problem.

Senator Warren has also accused the consortium of banks that own Zelle of hiding information about these scams and fraud cases. Zell's parent company, Early Alert Services LLC, called the report "misleading" in an October 2022 press release. Zelle says more than 99.9% of payments are sent without any reports of fraud or scams. There have also been reports of fraudulent activity at PayPal, Venmo, and Cash App. All four companies provide resources for consumers to better protect themselves. One of the reasons P2P fraud is so complicated is because it is less about something inherent to the platforms. It's not like they're being hacked or their data is going down or anything, but it's more of a human error.

People are being scammed online, there is social engineering, there are scams and they are falling for it. Companies like Zelle and others will say: Well, the consumer has to work with their financial institution. We're not the bank, right? And I think that puts too much responsibility on the consumer. Currently, as things stand in terms of legal obligations and responsibilities, companies are required to investigate and comply with certain requirements, but consumers can still largely be liable for up to $500. So that's problematic. Most of them look at it on a case-by-case basis. They will then listen to what the situation was and then make a determination as to whether or not those funds should be returned to the consumer.

And there are also times when they will work with the receiving bank and try to recover those funds. That doesn't always work because if the funds are already withdrawn from the account, what are you going to do? The challenge is that once you're online, there are ever-evolving types of schemes. And yet, I would say that with respect to all companies, not just Zelle, beyond education, you don't really see the technology keeping pace with the methods that consumers can use (a) to slow down the transaction , and yes see companies responding there, or (b) if we are in a real-time transactions and payments space, are there real-time solutions to manage and prevent fraud?

And who should take responsibility? There are some mitigations on how much money you can send at a time, but scammers are creative. So I think what we will need and what I hope to see in some form is some ability to rein in and provide some assurances to the consumer around reversibility or, effectively, a chargeback. They are working to solve the fraud problem and they are actually taking three approaches to solve it. The first is a technology-driven approach. Basically, they use AI machine learning to better ensure that senders and recipients are who they say they are on the back end.

There are also education campaigns. When you send money, you may receive a message that says, "Are you sure you're sending this to who you think you're sending it to?" simply to try to prevent fraud before it happens, making consumers more aware that it is a risk. And then the third is this rumored refund plan that came to light late last year. Under this plan, banks would determine whether a fraud claim is legitimate and then the bank that owns the account where the funds were sent would reimburse the victim. So if I sent you money and you were a scammer, your bank would be responsible for returning the money to me if it was proven to be a refundable claim.

The competition in this space is really fierce, but complicated because it is very common for people to use multiple applications for different use cases. So I would say that most P2P users are on more than one of these platforms and potentially even all four, but they use them in different ways. Companies compete to gain a greater share of users in different age demographics. Only 20% of people over 65 said they use Zelle, while 41% said they use PayPal, according to a Pew Research Center survey from July 2022. What we're hoping to see is more older people, who have With greater financial means, higher incomes are beginning to adopt fintechs as their primary way of accessing financial services.

Generation Z and even Generation Alpha are all digital all the time. They live and die by their smartphones. Everyone wants to reach this population. Cash App has already launched an account for teenagers. Venmo appears to be exploring it this year. So it's an exciting opportunity for growth potential because if you can get people when they're very young, they may form habits around you that last a lifetime. The brand is useful because you're not looking at Wells' individual P2P payment mechanism or Citi's individual payment mechanism. It seems very cohesive across the landscape of financial institutions participating in the network.

So I think all those things bode well. They are trying to eliminate some of the common challenges of interacting with the banking industry, while Cash App, PayPal and Venmo are really growing from the viral P2P benefit. Vendors are trying to offer new features. I'm interested to see how they seek to strengthen relationships and increase their volume through these new offerings.