Digital Wallets: Solution in Search of a Problem?

The release of Apple Pay has rejuvenated the debate about digital wallets. What may be most interesting about that is that a) there was a debate and b) that it needed to be rejuvenated.

The presumption that phones are that much more efficient or effective than credit cards has not yet been conclusively demonstrated. It is still early in humankind's evolution to a digitally dependent economy and consumer response or initiative remains a work in progress. There is certainly a cool factor involved, and when it comes to technology implementation, it is always a mistake to ignore the impact of fashion.

But Google Wallet has been with us for what feels like a long time. And the various banks, retailers and credit card companies involved have so far failed to either dominate as they do in other areas of tech, nor have they rocked our world. 

The reality, as the following article explains, is that much of what constitutes digital commerce is already in place. What remains is influencing the degree to which consumers wish to use it - and then how they go about doing so. There is a lot of money to made in shaping those preferences. The digital wallet gives some players more leverage - or less - so its evolution may be dependent on how the financial, regulatory and technological structures that frame them will ultimately be designed - and by whom, for whom as Apple has just demonstrated. JL

Adam Levitin comments in Credit Slips:

What's special about Apple Pay is that it links the payments data you enter with a data transmission system. The transmission system is what's important, not the digital storage of payments information.

Interesting op-ed on digital wallets by Edward Castronova and Joshua Fairfield in the NYT. I'm a little more skeptical. Thoughts follow the break.

(1) We already live in a world of digital currency.
Thanks to fractional reserve banking and electronic records, most currency and transactions are electronic now, not cash. Most money is already digital; there is a right of paper convertibility, but we're in a digital currency world without involving Satoshis and Ripples (¿or is that ripplakh?).
(2) Government Acceptance of a Currency Matters...A LOT. 
I would take issue with Castronova and Fairfield's claim that "the value of a currency lies in what you can buy with it, not in the fact that a government says it’s worth something". This statement overlooks the fact that the government plays a major role in the economy, as a taxing authority, a creditor, and a disburser of benefits. We have to be able to pay taxes, fines, fees, etc. and we can only pay them in the currency the government accepts.  That's part of the importance of the legal tender statute.  To wit, consider how the world looked before 1863. There were a wide variety of currencies used in the United States--every bank issued its own bank notes, and there was no standard paper currency. Taxes had to be paid in specie (and this continued even in the national bank era for customs duties). Government acceptance of national bank notes for taxes was key in their adoption (p.9). If can't pay my taxes in Satoshis or wampum, they are of limited use to me. Cryptocurrency advocates don't seem willing to take the legal aspects of currency seriously. They matter. A lot.
(3) What's a Digital Wallet? 
The term "digital wallet" gets used a lot without much precision. It's important to understand what a digital wallet is, and isn't. A digital wallet is simply an application that allows one to store information about multiple payment accounts, just like a physical wallet. A digital wallet is not a payment system, although it can be connected with one. A payment system is a system for the transmission of payment data authorizing a movement of units of value.
There are plenty of digital wallet apps around--all one needs is to use Apple's Notes app to enter one's card/account data, and viola, you have your very own digital wallet.
Some digital wallets are "closed wallets" that permit use of only certain payment options, while others are "open wallets" that let the user store any type of payment option. Apple Pay, for example, is a closed wallet product. What's special about Apple Pay is that it links the payments data you enter with a data transmission system. The transmission system is what's important, not the digital storage of payments information.
(4) Do digital wallets render themselves obsolete?
The huge potential benefit that Castronova and Fairfield identify with digital wallets is the (still theoretical) ability to seamlessly convert value among the huge range of currencies in use--not just dollars and Euros, but also bitcoins, and retailer reward programs (essentially a type of scrip).
While I appreciate the identification of retailer reward programs as a type of currency, I don't think Castronova and Fairfield push enough on what digital wallets mean for these programs. Why would a retailer offer a rewards program in some form of scrip rather than in terms of a straight price discount in dollar terms?
The answer is that retailers get (they hope) more bang for the buck because their rewards programs are (1) hard to value and therefore suspectible to overvaluation by consumers, and (2) not-interchangeable, thereby creating a loyalty element. In other words, retailer rewards are attractive to retailers precisely because they are clunky and sticky. They aren't really like money, which is easy to value and freely exchangeable. Make retailer rewards efficient, and there's no reason to offer them. A seamlessly integrated digital wallet world destroys both of these benefits. If retailer rewards function like any other currency, there's no reason for retailers to offer them instead of a plan price discount.Now that might well be a great outcome for consumers--monetize everything and it will have commodity-like efficiency--but I don't think we can assume that the world will remain static in the face of digital innovation. What does this mean equillibrium is likely to look like?  No idea, but with Big Data, we might well see much more individualized rewards scrip offers.
(5) Is There a Problem That Needs Fixing? 
Interchangeability isn't a payment systems problem per se; it's a currency conversion problem. While payment systems are often tied to a particular currency, but they needn't be, and some have a currency interchangeability element built in. Indeed, one of the amazing features of the credit card system (and PayPal too) is its built-in currency conversion. When I make a purchase abroad, I am billed in dollars based on whatever exchange rate the card issuer is using. (Yes, I'm aware that there were problems with the rate of choice, but that's implementation, not concept....)
The credit card currency conversion option only covers national currencies--it won't let me redeem my rewards points at California Tortilla for dollars. And that suggests that there is some room to make for more efficient currency markets, namely ones that cover not just national currencies, but things like retailer rewards scrip.
There are various attempts to create exchanges for retailer rewards scrip, but I suspect it hasn't happened because it just isn't efficient to fix this problem. I don't see the lack of interchangeability of value in things like retailer rewards as a currently a major problem for US consumers or one for which there is real demand. This is mainly becuase consumers just don't hold that much value in non-standard "currencies" like retailer reward programs, much less in any particular retailer "currency."
To wit, how much effort is worth putting in to enable the interchangeability of the $0.50 coupon I have for a cup of coffee at the local non-chain coffee shop that is useable only one Wednesdays and Thursdays?  The maximum value that would be unlocked by interchangeability would be $0.50, and realistically, it would be less than that.  There's just no market for this "currency," and I don't think digital fixes that, in part because of the costs of getting these "currencies" into a digital system and maintaining them in the system.
Perhaps in aggregate there's a lot of value floating around in retailer scrip, but I don't see any way to efficiently make all of these programs interchangeable, much less with dollars, and if it does happen, these programs are likely to disappear or become much more individualized to the consumer, thereby defeating interchangeability.