On January 13, 2020, Visa announced that it was acquiring Plaid, Inc., for $5.3 billion. Given that few consumers have ever heard of Plaid and that the transaction is one of the largest private exits for a technology company—let alone a technology company in the financial services industry—the announcement prompted more than a few questions. Most of these questions were variations on a theme: why would Visa spend that much money for that?
A number of blog posts and articles have offered answers to that question. The first to press, Stratechery, explained the acquisition in platform terms, adding a bit of context to the story laid out by Visa in the deck that it released when it announced the transaction. Visa’s current business connects merchants to banks to consumers, and Plaid’s business connects consumers to FinTechs to banks. Looking at the recent growth in consumer-oriented FinTech businesses, the transaction was a natural extension of Visa’s existing business.
Dan Rosen and the team at Commerce Ventures followed with a similar take. They describe the transaction “as a watershed moment for FinTech.” Like Stratechery, Dan and team explain that the deal will deepen Visa’s relationships with FinTech businesses, and suggest that those relationships are additive to the relationships that Visa currently maintains. They also suggest that the transaction should be a wake-up call to banks. The transaction points to how easy it has become for non-bank financial companies to use services like Plaid to offer products to consumers that improve on the transaction, record keeping, and safeguarding functions offered by banks and other regulated financial institutions.
We agree, to an extent, with both of these perspectives, but we think that there is both less and more to the deal than some of the initial hot takes. That is, we think that the acquisition does deepen Visa’s relationships with the FinTech space. However, we are skeptical that deepening those connections explains why Visa felt that it needed to spend $5.3 billion to acquire Plaid rather than build its own service. To understand our perspective, it helps to back up and understand what role Plaid plays in the FinTech ecosystem and how its service is both different from, and similar to, the functionality that Visa already provides.
What Does Plaid Do Exactly?
Plaid plays an important role in the FinTech space that really does not have a parallel in other technology industries. With consumer permission, Plaid helps companies get access to consumer information held by third parties. Data access is not, generally, a meaningful issue in other technology industries. The businesses that define how most of us think about technology — Apple, Amazon, Facebook, Google, NetFlix, etc. — are products of a very specific technological context governed by open protocols and application programming interfaces (“APIs”). Open protocols and APIs serve as a common language that enable disparate systems (e.g., the email app on your phone and Gmail’s servers) to communicate. Any developer can request access to the Gmail APIs and offer any number of services to sit atop email, from mobile apps to encryption products.
The financial services industry is very different. There is no common API that every financial institution uses to make information available to developers, or even a common structure for making information available on an ad hoc basis. As a result, FinTech companies struggle to access consumer data held by financial institutions.
Plaid seeks to solve this problem. Plaid combs through the various ways that financial institutions make information available, negotiates with them for access to information, and uses a broad array of data retrieval techniques to gain access to the data. Further, they layer on sophisticated error detection and correction to mitigate the low quality of the information they often receive.
There are two primary ways that FinTech companies (Plaid’s customers) use consumer data held by financial institutions. First, an application can request information about the current status of an account and recent transactions. Companies like Digit and Dave use status information like a consumer’s current bank account balance to determine whether a customer has sufficient funds to avoid an overdraft or make a savings deposit, while companies like Albert sift through consumer transactions to help users understand how they’re spending money.
Second, Fintech companies use Plaid to verify consumer account ownership. Because account and routing numbers are on the bottom of every check, knowledge of those numbers itself is not adequate proof of ownership. Using Plaid’s APIs, however, third party Fintech companies can verify account ownership without needing access to the account itself.
Why The Deal Isn’t (Just) About FinTech
From our perspective, the emphasis on the current FinTech ecosystem or even the expected growth of that ecosystem misses a larger point about an imminent tectonic shift in the payment industry.
Circling back to the two functions that Plaid supports — confirmation of account ownership and balance lookups — are two of the three functions that make up the core of Visa’s payment system.
When a consumer presents a Visa card to a merchant to consummate a transaction, Visa’s system enables the merchant (1) to confirm that the cardholder is authorized to use the account, (2) to determine whether the account has sufficient funds to cover the purchase, and (3) to receive a guarantee of payment. While Plaid provides these first two services, it does not provide the third, which is labeled in the industry as “settlement”.
Consumers and merchants have relatively little visibility into the complex systems that enable a Visa transaction once the interaction at the point of sale is complete. The consumer gets whatever she wanted to buy and, if she happens to look at the account associated with the card used, will see a hold in the amount of the transaction.
For the merchant, things are slightly more complicated. Some transactions, like those involving tips, require adjustments after the consumer agrees to the terms of the sale. And, of course, the merchant does not get paid right away. The actual receipt of funds follows the consumer’s payment by two to three days on average.
That last observation — the delay in the movement of funds between the time that the consumer agrees to terms and the time that the merchant actually receives funds in connection with the transaction — explains why the settlement process is, from a network perspective, so complex. In the wake of a transaction, Visa orchestrates a vast symphony of messages across as many as a three financial institutions to do two things: (1) shift the risk associated with the consumer’s payment obligation in connection with the transaction from the bank that has promised to pay the merchant, to the bank that issues the consumer’s cards; and (2) move the funds between those two institutions.
A Glimpse Into the Future of Payments
The fact that Plaid does not help financial institutions settle transactions means that no one should look at it today and see a rival to Visa. Visa and MasterCard have built enormous businesses around managing the movement of money between financial institutions. Plaid does not do that. But the vast machinery that Visa and the other payment networks have built to enable settlement may soon be rendered obsolete.
Visa and MasterCard have built elaborate systems to make it seem as though electronic payments move as quickly as cash. Cash is not, all things considered, as efficient or convenient as a payment card. Cash is bulky. It is prone to theft. A consumer has no recourse if a dispute arises after a cash transaction occurs. But cash does have one very significant benefit relative to an electronic payment, settlement of cash — i.e., the actual transfer of value — is immediate. With a tokenized payment system like cash, the transfer of the token effects the transfer of value.
It is possible to build electronic payment systems that have this same feature, though none could currently support the volume or complexity of the business managed by Visa and MasterCard. Distributed ledger systems like the Bitcoin blockchain, the Ethereum network, and Ripple all rely on cryptographic tokens to represent value. As with cash, settlement between counter-parties occurs once the network validates that a token has passed from one address on the network to another. But these systems do not connect easily to the banking system.
While bank settlement systems in the United States and elsewhere have begun to make faster payment available to participants, banks are unlikely to challenge the card networks’ oligopoly. NACHA, the operator of the largest US network for ACH transactions in the US, now supports next-day settlement for some transactions. Its sometime rival, the Clearinghouse, has opened up a real-time settlement system. But access to these systems is controlled by banks, and banks are not particularly interested in creating alternatives to Visa and MasterCard.
The walls are crumbling, however. The crypto community has fallen head over heels for fiat-backed instruments. Libra is, of course, the most obvious example. Although it is not operational, several fiat-backed crypto instruments currently exist, though use remains limited to the trading of crypto instruments. And Central Banks outside the United States are opening their settlement systems to participation by non-banks. Although it is hard to imagine the Federal Reserve under its current charter bending to such demands in the United States, it too has grown impatient with US banks’ sluggishness in moving to faster payments.
If settlement were a solved problem, Plaid’s ability to provide confirmation of account ownership and visibility into the account balance could provide a two-thirds of an alternative foundation on which to build a retail payment system. There would still be some difficult operational issues to solve. The sponsor of such a system would need, for example, to figure out how to manage post-transaction disputes between consumers and merchants. But, assuming that the system sponsor could enable real-time payments, the basic building blocks for a rival to the existing networks — identification, balance confirmation, and settlement — would be in place. Such a system would not rely on bank permission to move funds from consumer to merchant. Plaid’s authority to confirm account ownership and account visibility, comes not from the financial institution that serves as the custodian for the account, but from the account holder. A Plaid-based alternative to the card networks would raise the specter of network and bank disintermediation. Given that the market cap for payment businesses built around the existing bank-centric model for payments approaches $1 trillion, we can understand why Visa would part with $5+ billion to hedge against that future.
Like other FinTech investors, we are encouraged by Visa’s endorsement of the space. We will continue to look for companies that use Plaid and other similar services to help consumers and businesses better access and manage their finances. But we are very interested in what a payment industry built on top of a real-time settlement systems will look like, and Visa’s purchase of Plaid suggests that it, too, shares that interest.
¹Tom Brown is an advisor to Financial Venture Studio. He also co-chairs the FinTech practice at a global law firm. The views expressed in this article do not represent the view of his firm or any of its clients.
²Tyler Griffin is a partner at Financial Venture Studio.