The Business of Wallets

What Exactly is a Wallet?

Many consumers no longer carry physical leather or plastic wallets to hold identification, cards, and cash. All of these either live directly on cell phones or hang out in phone cases. But industry saw that transition coming long ago and vied to get the most valuable bits about money onto electronic systems in an enduring manner. It called the customer-presenting elements of those systems "electronic wallets," which quickly got shortened to "wallets."

Usage of this term has bounced around over years as various product teams have tried to one-up competitors or emphasize that what they're doing is merely wallet-adjacent or a superset of wallet functionality. Nonetheless, it's useful to look around the world and recognize what definitely got pitched as a wallet.

In 2024, a clarification became necessary: crypto enthusiasts repurposed "wallet" to mean "a collection of private keys controlled by a single entity" and then "the software artifact which, given an instruction to move money from A to B, would assemble that money from separately kept accounts corresponding to a list of private keys and send the relevant crypto network a candidate transaction for inclusion in the blockchain." These are not the sorts of wallets under discussion here. For crypto enthusiasts, it's instructive to contrast how crypto wallets make money versus how these wallets make money.

The Regulatory Question

Frequently in finance and surrounding technology, relatively small questions swing huge doors regarding regulatory and partner complexity for bringing something to market. The small question with large implications about wallets is: "Can it hold a balance of actual money?" If it holds actual money, that starts looking to regulators an awful lot like a deposit product.

Regulators strongly prefer that deposits stay within the regulated banking sector. The single largest reason is concern that households' immediately accessible stored funds stay safe and accessible. A major follow-up reason, less understood by non-specialists, is that regulated banks are bound to long lists of consumer protection items on the transaction level, not the institution level. Much abuse in the economy happens in $50 and $5,000 increments, rather than multi-billion dollar increments. Regulators sleep better knowing that this abuse happens at companies with teams of operators standing ready to address issues rather than sticking users with losses.

Early Internet: PayPal's Innovation

The granddaddy of wallets was PayPal. In the early days of Internet commerce, nearly 30 years ago, many users were askance about typing credit card details online. In some countries, this would have been banking details. The physical capability to pay with banking details lagged cards so dramatically in places like the U.S. and Japan that online commerce became synonymous with card use early. This persisted for decades, though it's no longer strictly true.

The Security Scare

Younger users may not appreciate this, but there were front-page newspaper stories that scared large parts of the population that typing credit card numbers into any keyboard would result in theft by hackers. There was a purported raft of fake e-commerce sites where bad actors would spend millions creating convincing facsimiles of real e-commerce sites, just to steal credit card details. This was probably never actually a major threat by percentage of all stolen cards, not when these articles were written or afterwards, but this wouldn't be the first or last time media convinced itself of an untruth and was unable to find industry insiders to leak SQL queries dispelling their fantasies.

The largest source of purloined credit card information is scaled breaches of card issuers or companies that were legitimately presented hundreds of thousands or millions of cards in commerce. Organized crime does not outscale capitalism - the threat is when it gets to piggyback illegitimately on capitalism.

PayPal's Value Proposition

PayPal's initial value proposition: convey money from payment instruments to others on the Internet (by volume, mostly eBay auction sellers) without needing to show those potential devious hackers actual credit card numbers. That way, exposure was upper-bounded at the single transaction in progress, and hopefully PayPal or banks could intervene if something went wrong.

But then eBay sellers ended up with money... and what were they to do with it?

Stocks vs. Flows

There are classically two ways to make money in financial product innovation: charge customers for stocks (ongoing and often percentage-based fees to custody assets for arbitrarily long times) or charge them for flows (per-instance and sometimes scaling-with-size fees on transactions specifically). Very frequently, from single users' perspectives, stocks are priced and flows are free, or vice versa. In basic bank accounts, stocks are priced (via interest rate spreads on deposits) but transactions are free or close to it. In credit card processing for businesses, stocks are free-ish but flows (incoming transactions from customers) are priced.

Do wallets with embedded cash make money from stocks or flows? Yes - both.

PayPal's Enduring Genius

The enduring genius of PayPal's wallet money was that moving money into PayPal's ecosystem cost substantial amounts via card interchange. PayPal would try to set pricing, historically about 2.9% plus about 30 cents, such that it was above most interchange fees they'd eat moving money into the system. Then they would strongly encourage users to keep balances within PayPal. This was natural for many casual eBay sellers who were also buyers, rather than being professional antique dealers - leaving their Internet money somewhere on the Internet until next needing money on the Internet worked out fine.

When customers did next transactions, paying from PayPal balances to other PayPal users, money moved internally at database transaction speed and cost: approximately instantaneously and too-cheap-to-meter. Then PayPal would try, with varying levels of success, to charge the full 2.9% plus 30 cents, this time making 290 basis points of margin rather than 80-120 basis points or so.

Supercharging margin possibilities by disintermediating card ecosystems is the primary economic advantage of wallets capable of holding balances. This is emphasized because non-specialists routinely assume that things looking like bank deposits, and might actually be bank deposits under the hood, must earn revenue the same way bank deposits earn revenue - via net interest margin. They do, and in high-interest environments like the current U.S. market, this is lucrative. PayPal earned nearly $500 million in interest on customer balances last year. Most of that is very high margin revenue, but it's not the ballgame. The real prize is having vastly better economics on transactions.

The Math Per Account

It's easy to see this when zooming into single account economics. PayPal claims accounts on average have about 40 transactions per year. Assuming a typical consumer might carry $200 in balance and do 10 transactions each about $40 per year, that's something like $10 of margin from net interest and either about $1 of margin from transactions if transactions are funded with the most expensive credit cards or about $15 of transaction margin if they're just repeatedly funded by PayPal balance.

A subtlety: how do you do $400 in transactions out of a $200 balance without extending credit? You convince consumers to let you top up their balances via ACH pulls or similar methods, which (unlike card transactions) are very close to free.

What Does an ACH Pull Cost?

The cost of an ACH pull depends on many things, like negotiating savvy and volume. But if one were to guess "maybe it costs 5 cents when buying hundreds of millions of them," that would be in the ballpark.

If checking what payment processors of choice charge businesses to do their own ACH pulls, quoted numbers are closer to 30 cents. This shouldn't surprise anyone - payment providers are in the business of earning margin on underlying payment rails the same way Coca Cola is in the business of earning margin on combinations of water, carbon dioxide, and corn derivatives. Coke also structurally gets much better prices on corn because Coke buys agricultural output of Iowa while consumers buy a few ears from supermarkets.

Many readers live in nations where interbank transfers do not go over ACH rails. In those nations as well, interbank transfers are broadly speaking much less expensive than most card transactions.

Extensions: Debit Cards

After running wallet operations for a few years, product teams start clamoring that they have attractive ideas which will make wallets stickier with users, encourage best customers to move more transactions to wallets, and decrease payment costs. They'll also sometimes make incidental revenue.

The Obvious No-Brainer

The first option is making debit cards backed by wallet balances, with cards issued by banking partners that (in the U.S.) are certain to be Durbin-exempt institutions. This is an obvious no-brainer, product teams will argue. Currently, when users want to get money out of ecosystems to bank accounts, wallet providers pay money. Why not earn money instead? Get co-branded debit card offerings and banking partners will provide revenue shares on every transaction out. (How much is something of a trade secret, but thinking somewhere in the 100 basis points ballpark would be close enough to interview as a PM at a fintech company.)

Cash App is, if you squint, a wallet. Block product managers would probably heavily dispute this characterization and say, truthfully, that their core user feels like they're using Cash App rather than using their linked Bank of America debit card when paying with Cash App. But economically, it looks an awful lot like a wallet. And Cash App has morally speaking a debit card which Cash App users can use anywhere in the economy that doesn't take Cash App directly. Each time they do, Sutton Bank earns swipe fees, portions of which become Cash App transaction revenue. These payments are reasonably assumed to be very large chunks of their $498 million in revenue in that segment.

Monetizing Payouts

Sometimes there's money inside ecosystems that users need taken out in a hurry. A common Cash App use case is texting to request small amounts of money or requesting roommates' fractions of rent. Users might need to very quickly convert those few hundreds dollars into forms of electronic money accepted broadly. Cash App will facilitate this, for 0.5-1.75% with a 25 cent minimum depending on exactly what rails the money goes over.

For example, if landlords require rent payment via Zelle or check, tenants might want to fairly urgently send money to accounts at banks which can do both Zelle and checks. There are two ways: via ACH push payments to banks, which would typically arrive in a few days, or via quirky forms of "reversing transactions that never happened" on debit cards, which arrives almost instantly.

Cash App likely charges 0.5% (25 cent minimum) if they push over cheaper ACH rails and 1.75% (25 cent minimum) over more expensive debit card rails.

Credit Card Partnerships

Why only let users spend money they already have, when they could spend money they might not already have? Co-branded credit card offerings make sense. Wallet providers will not issue credit cards - no, regulators consider issuance of consumer credit an exclusive domain of the regulated financial sector. They will partner with members of that august community and those partners will issue cards, which will simply have wallet provider names on them.

Why Do This?

One reason: it lets customers spend money which does not exist in ecosystems, in ecosystems, and instead of paying to move money into ecosystems, wallet providers get paid coming and going. Users charge money to cards (which co-branding partners will pay fees for) and then it moves to some business through the wallet (earning another fee). They're also highly likely to get another success fee for every card account successfully opened, which might be used to incentivize users opening cards, kept for themselves, or split to do both.

See, for example, the Venmo card. Card issuers are getting more sophisticated in how they differentiate offers, which possibly causes PayPal (Venmo's parent) to get more sophisticated in how they make offers. Venmo has been willing to pay $200 if applicants apply within 2 weeks and spend $1,000 in next six months. Ranges of per-account and usage-based payments from Synchrony Bank to PayPal can be constructed which makes this immediately incentive compatible for PayPal.

Negotiated Terms

A fun thing about negotiating issuing relationships: everyone and their dog will say they have Alternative Data with Big Data levels of transaction history allowing issuing banks to underwrite heavy wallet users better than typical prospects. Spoiler: this won't actually end up mattering for credit decisions. FICO scores are unreasonably effective. Many teams have thought supplementing FICO scores with another data source would yield better loss rates, but just about the only data sources for which that's actually true are illegal to use.

The big win on loss rates isn't additive data that wallets have. It's negotiated terms between wallet providers and card issuers. Card issuers aren't interested in individual consumers' decisions to pay or skip on debts. They're attempting to buy portfolios from wallet providers, and they negotiate about those portfolios.

A fairly common term: "Across all accounts we issue on the co-branded card, we model a certain loss percentage. Now we're going to construct a graph. If you slightly underperform that loss percentage, we're going to cut out payouts to you a bit. If you greatly underperform that loss percentage, we're going to cut them by more. And if you somehow have an absurdly fraudulent user base which nonetheless makes it past our own underwriting, we will demand a payment from you."

Phone-Based Wallets

Many wallets exist as apps on phones, but phone makers have realized that phones have replaced leather wallets, and consider walletness of phones to be as core a product feature as making phone calls.

Two very successful wallets are Apple's wallet (more or less coextensive with Apple Pay) and Google's wallet, plus Samsung Pay.

Apple's Pitch to Banks

Apple's pitch to banks is essentially: "OK, you might buy that many well-heeled users like their American Express cards. That certainly sounds reasonable. Do they spend hours stroking their American Express cards lovingly? Do they bring them out to gaze upon as they sit on toilets? No? OK, users care about our plastic-and-glass artifacts much more than they care about Amex's plastic-and-glass artifacts. But good news. We can digitize your thing that users yawn about on the thing that they love, and then it will outcompete all other payment methods because it's not in their wallets, it's in the palms of their hands basically all their waking hours."

This was pretty contentious, but banks agreed to pay Apple for privilege of inclusion in this wallet. Partially this was because Apple might have said something rhyming with "If you don't do this, we will find two-sided payment networks willing to do business with us. If we can't find them, we will build it, and people will use it, because they like us more than they like you."

Apple has been publicly reported to make 15 basis points on each transaction going over Apple Pay. Google reportedly doesn't make anything for intermediating transactions, which if believed might suggest something about relative executional capabilities of Apple and Google on non-core products.

The Ads Business Parallel

Many scaled Internet firms have looked at these economic models and decided to jump into the wallet business. The economics are extremely compelling and additive to almost any business which already needs to move money around on behalf of users.

This has occasioned some observation of how they compete against each other, with numerous one-button checkout options vying for placement on merchant checkout pages.

A Consumer Internet Product Manager's View

Here we have numerous different firms vying for user attention, where experiences between those firms all lead to essentially the same outcome (users bought goods/services for prices from businesses), where there might be bit of user preference, but where many users are highly persuadable.

Good consumer Internet product managers will say at this point: "This smells like an ads business. Do you have any idea how much money ads businesses make? It's absurd."

Now if product managers prioritize outcomes of transacting businesses they represent, they might have prioritization algorithms other than "who paid me the most for placement." For example, businesses choosing their own ordering of those providers might say they really prefer to maximize net margin rather than simply maximizing side payments. They're in business to sell things to people for money, after all, and checkout pages are only incidental to that.

The Optimization Reality

Surprising almost everyone, almost no business below the scale of the largest businesses in the world, and few enough of them, actually has teams of people who run experiments on checkout flows to optimize for conversion rates (percentage of people who successfully check out). This was striking when revealed through industry conversations over many consecutive years.

Some providers took advantage of rendering checkout flows for very many customers in parallel and introduced dynamic optimization of payment method presentation at checkout. This takes advantage of previous user preference in various geographies, so that people transacting in America get prompted for cards like they probably expect and people transacting in Japan see both cards but also popular Japanese payment methods. The conversion rate impact is much larger than many people guessed prior to doing it.

Fast Checkout Solutions

Most wallets are designed to make wallet providers money via various revenue streams. Some offerings are designed to convert very well and get network effects for businesses.

Businesses can allow customers who start checkouts by sharing identifying information like email addresses or phone numbers to quickly reuse payment credentials they linked in previous transactions at that business or another business using the same system. Since that's a sizable fraction of businesses, users attempting to transact are highly likely to have used currently-available payment methods before that the system knows about, allowing them to re-use it without redundantly typing numbers.

The Realization

A fun bit of history: once someone visited a fintech office and wanted to show off having figured out how to query an internal data store, asking "What's your over/under on the percentage of cards used this year that we have seen before?" That number was pretty mindboggling even years ago, and an obviously good marketing point.

Similar products are born out of realizations: if users have typed in card details once, and if they're OK with it, they should be allowed to redundantly type those as infrequently as possible. This is an obvious user experience win. Businesses should like it too, to the extent it outconverts other ways of presenting checkout, which can be dynamically measured all the time. Providers like it because improvements to conversion rate at the margin mean they get to charge fees on more transactions.

Another Business Rationale

Now imagine another good business rationale: providers' two largest costs are smart people and card interchange. One of these is fun to cut.

Many customers have strong preferences about how they conduct transactions. They might really like their credit card rewards. For those users, sure, let them do the thing they want to do.

For other users who do not have strong preferences, perhaps because they're not in socioeconomic strata that directly benefit from rewards programs, businesses sensitive to cost of interchange can subsidize incentives for typing low-cost payment credentials into mobile phones once. Those businesses might have repeat custom with those users, and recoup that incentive over lowering their payments costs on many transactions over months or years.

Think, for example, ride sharing services. Core customers ride twice daily, every weekday, for arbitrarily long periods, and every time businesses charge them they pay issuing banks again for making acquaintances of those customers. If ridesharing businesses could convince customers to pay with bank accounts instead, that would be beneficial enough over terms of those relationships that ridesharing businesses could directly pay for that simple one-time action.

Then, next time those riders go to check out at other businesses, if they've agreed to save those payment methods... those businesses passively benefit from lower payment costs.

A Scaled Renegotiation

In essence, it's a scaled renegotiation between businesses that ultimately pay for payments and providers of payment services: the logic is understood that more is paid for customers that really love certain services. If they really love those services, great, hearts have been won and business will clearly continue to be won. If on the other hand customers perceive services as commoditized... then payment services will be bought from commodity providers of them.

The price of payment services is a contentious topic between businesses and businesses that operate payment rails. There has been substantial litigation about credit card interchange fees in the U.S., for example.

As one tiny piece of that, Walmart has opposed a settlement, explaining to judges that it has economic heft to negotiate serially with largest banks in the U.S. on interchange and would do so if Visa and Mastercard got out of the way. Most companies do not have nearly the scale of Walmart or operational capability to pick up phones and do months-long bespoke negotiations with one bank, to say nothing of 20 of them. Walmart makes this point at length - they don't want deals most companies will get.

But why shouldn't the Internet get deals the Internet could negotiate, if the Internet was capable of negotiating on its own behalf? Some providers, as side effects of wallet-like products, enable distributed, techno-social renegotiations of payment costs on behalf of the Internet. It's even aesthetically Internet - not single big bang negotiations ratified by judges, but rather aggregates of millions of individual purely voluntary decisions interacting with each other. This brings large numbers of small-to-huge businesses, and customers using them, to sides of tables. And given that sides of tables represent something like percents of global GDP, they might get listened to.

Conclusion

The business of wallets reveals how financial infrastructure can be reshaped by clever intermediation. By holding customer balances and facilitating transactions within closed ecosystems, wallet providers transform payment economics from paying card networks 2-3% per transaction to paying nearly nothing for internal transfers.

This fundamental economic advantage - disintermediating card networks - drives the entire wallet industry. While interest on balances provides nice supplemental revenue, the real prize is capturing transaction volume at vastly superior margins. PayPal pioneered this model, but it's now pervasive across Cash App, Venmo, Apple Pay, and countless other implementations.

The extensions - debit cards, credit cards, instant payouts, phone integration - all serve to deepen moats and capture more transaction volume. Each additional service makes wallets stickier and gives users more reasons to keep balances within ecosystems rather than moving money back to traditional banks.

For businesses, wallets present optimization opportunities and challenges. Conversion rates improve when customers can check out quickly with saved credentials. But payment costs vary dramatically depending on which wallet customers choose and how those wallets route transactions.

The future likely involves continued experimentation with wallet business models, particularly around leveraging transaction data, optimizing checkout experiences, and negotiating better payment economics on behalf of merchant networks. As phones fully replace physical wallets, whoever controls the digital wallet interface controls valuable chokepoints in the payment ecosystem.

Understanding wallet economics helps explain why so many technology companies - from messaging apps to ride sharing services - eventually build payment features. The economics are simply too compelling to ignore for any scaled platform that facilitates commerce.