There are lots of ways to pay.
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Up until the 1990s, transactions typically closed with the ceremonial handing over of cash, coin, or check for purchased goods and services. Money, in some physical form, was always present, more or less, in the process.
Although money still plays an essential role in all purchases, it now seems to operate behind the scenes, rarely occupying physical space. Nowadays, swiping or even tapping for a contactless purchase seems to be the norm. You can also send money electronically using an app on your phone or via your computer.
Although money canât be conjured out of thin air, it certainly moves through it.
Key Points
- Todayâs mobile payment systems began with the advent of the telegraph in the late 1800s.
- Payment systems have undergone plenty of changes, but some of the older and more well-established systems are still preferred.
- Digital currency payment systems may seem futuristic, but whether they have a future remains to be seen.
These days, sending or managing money via digital or electronic means seems as natural as breathing. Moving money just takes a keystroke, a click, or a tap. Still, understanding how money moves, in what forms, and through which virtual avenues, can help you identify opportunities for savings and investment as well as mitigate risks, especially when you canât see your moneyâs virtual path.
Electronic money transactions come from the Gilded Age
Sending fiat money digitally or using new forms of digital money are high-tech endeavors. But their origins date back to the era of steam engine railroads, in the 1870s, when Western Union debuted its electronic funds transfer (EFT), also known as a wire transfer, which used telegraph lines).
In 1910, the Federal Reserve first used the telegraph to transfer money. Fast-forward to the 1950s, when American Express introduced the first credit card. Transactions became instantaneous, including deferring payments and accumulating debt.
Electronic payments in the late 1960s through the 1970s saw a significant leap forward. Barclays Bank introduced the first automated teller machines (ATMs) in the UK in 1967, soon to be followed by Chemical Bank in the U.S. in 1969. The Automated Clearing House (ACH) was officially established in 1972. The Society for Worldwide Interbank Financial Telecommunication (SWIFT), a cross-border payments network established in Belgium, went live in 1977. These technologies were further developed throughout the 1980s.
But with the advent of the Internet and digital technology in the 1990s, electronic payments evolved at light speed, so to speak. This is where todayâs e-commerce, mobile banking, contactless payments, cryptocurrencies, DeFi, and central bank digital currencies all found their point of genesis.
There are lots of ways to move money electronically. Letâs review some of the most widely adopted approaches and look at how they work.
Debit cards are the most frequently used form of payment, accounting for about 28% of all electronic payments in 2020, according to the Federal Reserve Bank of San Francisco. Debit cards are linked directly to your bank account, so purchases are typically deducted right away.
How it works
- Query and authorization. As soon as you swipe or tap your card and type in a personal identification number (PIN), details of the transaction are sent to the merchantâs bank, which forwards them to the cardholderâs bank (issuing bank) for authorization.
- Thumbs-up or thumbs-down. Your bank does a balance check, approves or declines the transaction, and a notification is sent to the merchant.
- Processing and fund transfer. The merchant sends approved transactions for processing. Funds are withdrawn (debited) from your bank account and deposited (credited) to the merchantâs bank account.
- Recording. A record of the transaction will appear on your bank statement.
Straight out of the old bank account.
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Since their debut in the 1950s, credit cards remain a popular means of payment, second only to debit cards.
How it works
- Query and authorization. As soon as you swipe or tap your credit card, an authorization request goes to the merchantâs bank, which connects to your cardâs issuing bank via a credit card network (American Express, Discover, Mastercard, or Visa).
- Thumbs-up or thumbs-down. Your cardâs issuing bank checks your available balance against your credit limit, approves (or declines) the transaction, and sends a notification to the merchant.
- Processing and fund transfer. At the end of the day, the merchant sends the approved transaction to their bank. Settlement occurs when the credit cardâs issuing bank sends funds to the merchantâs bank.
- Credit card bill. The transaction will appear on your credit card statement. If you donât clear your balance by the due date, youâll owe interest in addition to the principal balance.
Swiping sets off a series of steps.
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Digital wallets like those offered by Apple and Google have been rising in popularity thanks to their convenience and promise of enhanced security. Instead of storing actual card or account numbers, these wallets use encryption technology (âtokenizationâ), which theoretically ensures safer transactions because information isnât shared directly with merchants. When you tap your phone to pay, it communicates with the merchantâs point-of-sale (POS) terminal using near-field communication (NFC) technology.
How it works
- Set up your wallet and enable NFC. Most digital wallets allow you to link to credit cards and/or debit cards. Before you use one for a transaction, set your preferred payment method and turn on your deviceâs NFC.
- Tap the device to pay. Hold your NFC-enabled mobile device and app next to the NFC-enabled POS terminalâtypically the same device that processes tap-to-pay credit or debit card transactions.
- Token sent. The digital wallet sends a one-time token in place of your actual card number. The payment terminal processes it like a normal debit or credit card transaction and confirms the payment, often with a beep or on-screen message.
- Processing and fund transfer. The POS communicates with the merchantâs bank; processing and settlement follow either the debit card or credit card flowchart, depending on the payment method chosen.
No card needed; you have your phone.
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The use of peer-to-peer (P2P) payment apps like PayPal, Venmo, and Cash App increased significantly during the COVID-19 pandemic. Mobile payment apps encrypt data and may use additional authentication (such as fingerprints) to authorize transactions.
How it works
- Initiate payment. Open the app, select (or add) the recipient in the app, and enter the payment amount to be sent.
- Accept/decline. The recipient is notified about the payment and can accept or decline it. Assuming the recipient accepts the payment, the app debits the senderâs balance or linked bank account.
- Account debit and credit. The debited funds are credited to the recipientâs app balance. (If the recipient isnât set up with the app, theyâll receive a notification with instructions, including the option of keeping the balance on the app or transferring it to a bank account.)
- Processing and fund transfer. Although fund transfers within the app can be instantaneous, settlement of funds (transferring money from the senderâs to the recipientâs bank) can vary from an hour to several business days (depending on the app).
Pay from the comfort of home (or wherever).
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These payment systems occupy center stage in todayâs money culture, but there are other ways to move moneyâfrom old and established to emergingâthat also play an important role.
Bank transfers. Banks can move money directly between accounts in several ways. Wire transfers send funds quickly, often the same day, and are commonly used for large or time-sensitive payments. Other transfers move through the Automated Clearing House (ACH) network, which processes electronic checks, bill payments, and direct deposits such as payroll, Social Security benefits, and tax refunds.
Prepaid cards. Unlike debit cards linked to a bank account, prepaid cards draw from a balance loaded onto the card in advance. They can be useful in situations such as travel, budgeting, or gift-giving.
SWIFT. Banks, financial institutions, central banks, and government agencies still rely on the Society for Worldwide Interbank Financial Telecommunication (SWIFT) to make cross-border payments.
IBAN. The International Bank Account Number system facilitates fast and secure cross-border payments between financial institutions and governments. IBAN is mainly used in Europe, but also in a number of non-European countries.
Cryptocurrency. Crypto like Bitcoin, Ethereum, and others can be used to make secure, decentralized transactions via blockchain technologies. Adoption remains limited, but interest in crypto has continued to grow.
The evolution of money transfer from tangible cash to digital currency shows us something about the power and speed of human innovation. Rooted in the Gilded Age, money went from tapping code to a coded tap via encrypted app.
As a consumer, understanding the mechanics and origins of these systems can help you make informed decisions about how you send your money. As an investor, it gives you insight into the future of commerce, highlighting areas of potential opportunity and risk within the emerging electronic payment landscape.
This article was most recently revised and updated by Karl MontevirgenThis article was most recently revised and updated by Doug Ashburn
