ADDITIONAL PRAISEFOR Virtual Banking

“For too long fi nancial services has lagged behind other industries in under-standing and adapting to new consumer expectations of service. This bookshows how they can stop falling behind by becoming part of the emergingnew ‘innovation eco-system’ and adopting new ways of working, especiallypartnering with smaller innovative fi rms.”

—David Milligan, CEO, Matchi.biz

“Virtual Banking is full of practical advice, built on careful analysis andgthoughtful predictions, such as the future of mobile banking. A call-to-action for an industry that desperately needs deeper innovation-minded partnerships.”

—Michael Strange, CTO, Mitek Systems

“Financial technology has advanced dramatically in the past two decades, but in recent years we’ve seen major banks and institutions embrace data processing technologies to be more effi cient. In the 1990s, the limitations of mainframe technologies hampered the banking industry’s ability to makeautomated decisions based on billions of data points. Today, parallel pro-cessing and scalable technologies have enabled an entire generation of al-ternative lenders, virtual banking products, emerging payment systems, andmobile tools for consumers, business owners, and the enterprise. Dan’s bookis a fantastic analysis of these evolutions and specifi cally how SMB’s have become more inclined to use technology to grow fast.”

—Darian Shirazi, CEO and Co-founder, Radius

VirtualBankingBanking

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The Wiley Finance series contains books written specifi cally for fi nance and investment professionals as well as sophisticated individual investors and their fi nancial advisors. Book topics range from portfolio management to e-commerce, risk management, fi nancial engineering, valuation, and fi -nancial instrument analysis, as well as much more.

For a list of available titles, visit our web site at www.WileyFinance.com.

A Guide to Innovationand Partnering

DAN SCHATT

VirtualBankingBanking

Cover image: ©Alex Belomlinsky/Getty ImagesCover design: Wiley

Copyright © 2014 by Dan Schatt. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

ISBN 9781118742471 (Hardcover)ISBN 9781118742549 (ePDF)ISBN 9781118742365 (ePub)

Printed in the United States of America10 9 8 7 6 5 4 3 2 1

To my wife Suzan—for agreeing to give me a tour of Bucharest 22 years ago and who remains just as charming, talented, and

beautiful 4 continents, 10 countries, and 2 kids later.

To Brianna and Demian—who regularly inspire mewith their own innovations and awesomeness

vii

ContentsContents

Foreword xiii

Preface xv

Acknowledgments xix

INTRODUCTIONInnovating through Scarcity 1

The Infl uence of Cloud on Innovation 3The Infl uence of Smartphones 4Big Data = Big Driver of Innovation 4Taking a Cue from Retailing 5The Enemy of My Enemy Is My Friend 6Reconciling Innovation and Regulation 6In Search of New Payment Revenue Streams 8New Skill Sets for a New Era 9A Road Map for This Book 9Notes 11

CHAPTER 1Consumer Empowerment Knocking at the Door 13How Mobile Is Reshaping Consumer Expectations in Financial and Retail

How Mobile Is Changing Consumer Behavior 15Mobile Is Blurring the Lines between Digital and Physical 17

Mobile Learnings from PayPal and Square 19Mobile Commerce through Tokenization 27The Mobile Camera—It’s Not Just for Pictures Anymore! 29The Mobile Microphone—Offers and Payments

through Soundwaves! 30NFC’s Rebound and the Promise of Host Card Emulation 31Apple’s Passbook 33The Apps Phenomenon 35

The Uber-ization of Mobile 36

viii CONTENTS

“Top of Wallet” to “Top of Mobile” 38The Case of Braintree and Simple 39

The QR Code 40What Banks Can Learn from Starbucks 41Leveling the Playing Field with LevelUp 43From Mobile Banking to Tablet Banking 45Mobile Models for the Emerging Markets 47What’s Next? More of the Same 51Notes 52

CHAPTER 2Social and Financial Services 55Maintaining Relationships and Relevance through Social strategies

Digital, Data, and the Future of Banking 58Social Media Experiences in Banking 60Gamifi cation 62Personal Financial Relationship Mapping 63Capitalizing on Social Banking 65Moven: Delivering Banking through Social Context 66Social Banking in Europe and Asia 70Social Login, Sharing, and Top of Wallet 71Peer-to-Peer Lending: Blending Social and Banking 73Beyond the Hype: Partnering for the Future with

Peer-to-Peer Lenders 74Lending Club: A Win-Win for Banks and Their Customers 75

Takeaways for Banks 79An Investor’s Perspective on Social Banking and the

Emergence of Bitcoin 80Message To Banks: Be a Smaller Part of a Bigger Pie 85Notes 86

CHAPTER 3Connected Financial Commerce 89Location-Based Services, Mobile Commerce, and Digital Wallets

The “Local” Digital Wallet 91The New Retail Experience 91Retail 2.0 and Its Effect on Payments 93Entrepreneurs, Developers, and Financial Services 95Context Banking: The Next Step 96Low-Energy Bluetooth, Hardware, and the

Future of Commerce 97iBeacon and EasyPay: The Future of In-Store Payments? 98

Contents ix

PayPal’s iBeacon: Proximity and Context 100Google Glass for Finances 101In Search of the Digital Wallet 102

Personal Financial Management 103Coupons 104Shopping Tools 104Loyalty and Prepaid 104Tickets and Passes 105

The Who’s Who of Digital Wallets 106Google 107LifeLock (formerly Lemon Wallet) 108PayPal 109Carriers 110Retailers 111Square Wallet 113

What’s Next? 113Notes 114

CHAPTER 4Innovating with Big Data and Open Platforms 115Competing in a World of Unlimited Data and Storage

The Rise of Platform Services 121Application Programming Interfaces (APIs) for

Online and Mobile Commerce 122Coping Strategies for Banks 123PayPal’s Bold Bet: Unleashing Innovation through

an Open Platform 125App Stores for Banks: Will It Work? 133What’s Next? 139Notes 141

CHAPTER 5Math-Based Currencies 143How Bitcoin May Prove Transformational to the Financial Services Industry

Entering the Age of Context 143Intro to Math-Based Currencies 146Why “Math-Based Currencies”? 147

MBCs Are a Reality 147History of Digital Currencies 148Math-Based Currency Characteristics 148Bitcoin: The First MBC 149

Bitcoin’s Brief History 150

x CONTENTS

Is It Bitcoin, bitcoin, or Just BTC 150Bitcoin Is a Powerful Concept 150

How Bitcoin Works 152Digging Bitcoin 154Digital Push Payments 156

Counterfeiting No More 156MBCs Enable Programmable Money 156

Completing the Bitcoin Ecosystem 157Bitcoin Exchanges 158Bitcoin Wallets—Where to Store Your BTC 159

Mobile Wallets 159Cloud-Based Wallets 159Bitcoin Hardware Wallet 160Bitcoin Vaults 160Trading Platforms 160

Bitcoin Use Cases in Payments 161MBCs as Payment Rails 161B2B Payments—The Known Counterparty 162Bitcoin and Consumer Payments 162

Buy Me a Beer 163E-Commerce and MBCs 163Getting Harder: Music and Video 164Challenges at the POS 164Improving Bitcoin Processes 164

Improving the Bitcoin Protocol 164Programming Bitcoin for a Special Case:

Online Micropayments 166Wallets 167

Ripple: The Second MBC 167MBC Use Cases in Banking 168

International Remittance Rails 168Interbank Settlement 169Building Trust with MBCs 170Automating Transaction Policies 171

Moving Ahead with MBCs 172Conclusion 174

CHAPTER 6 177The Smart PipeModels that Will Survive the Next Generation

The Prepaid Model 178Prepaid Nation: Redefi ning What a Bank Can Be 179

Contents xi

The “Underbanked” and Opportunities for Innovation 184Stockpile: An Example of Brokerage

Innovation Through Partnering 185MoneyGram: An Example of Innovation

through Partnering 186Innovative Ways to Expand Access—PayNearMe 189How Innovative Banks Are Partnering for Innovation 190The CEO-CIO Relationship Driving the Innovation of

ING DIRECT Canada 190A Whole New Era 193

How Banks Can Compete in the Future 194Three Imperatives to Partner for Innovation 196

A Venture Capitalist’s Look at the Future of Banking 198Technology as an Enabler and Partner 205What the Next 50 Years Might Hold 206

Digital 207Relationship Management 207Platform and Identity Friendly 208

The Future Bank Bundle: Platform-Relationship-Utility 208Notes 209

About the Author 211

Index 213

xiii

ForewordForeword By Renaud Laplanche

Co-Founder and CEO of Lending Club

When I founded Lending Club in 2006, I saw the potential for a new model to deliver credit, in a way that would transform the U.S. bank-

ing system into an online marketplace where investors directly fund bor-rowers, earning a return in the process and creating savings for borrowers. This transformation would allow the system to operate at a lower cost, be more transparent and more consumer friendly. As I started building Lending Club I came to learn from people like Dan that my vision was part of an unprecedented wave of technological innovations in fi nancial services. Thetask Dan took on–to provide a guide to such innovations–is enormously challenging, but as a former investment banker, industry analyst, and PayPalinnovation executive, he was uniquely qualifi ed to do so, and the result is a resounding success.

Today’s fi nancial services industry includes a plethora of technology companies, from new and innovative brokerage platforms like Stockpile, personal fi nancial management platforms like Personal Capital and Wealth-front, new models for banking such as Simple, payments processors like Braintree, and business services such as Swipely. The common thread tying all of these innovations together is the customer‐centric vision that brought them into being. Focusing on the consumer, rather than the product, as a starting point is one of the central themes of this book. Through its sixchapters, Dan deftly outlines the landscape of the fi nancial technology in-dustry, acting as an accessible yet deeply thought‐provoking tour guide to the rapidly changing fi nancial technologies from mobile to social to Bitcoin.

Now more than ever customers demand immediacy, relevance, and per-sonalization in their day‐to‐day behaviors. These trends are evident in the data and examples that Dan presents in the book. Consumers want to split checks with friends digitally at the restaurant (Venmo), request car servicebefore getting onto the street (Uber), and access their Starbucks loyalty and payment card while waiting in line (Square). These trends will not only con-tinue, but accelerate, as younger generations use their mobile phones for more transactions in their lives and are increasingly willing to share infor-mation and data with friends and fi nancial institutions alike in order to get more customized service offerings.

xiv FOREWORD

Dan doesn’t just describe the landscape at it exists today, he makes us consider the endless possibilities that tomorrow holds. What if your digital wallet not only pays for your purchase, but also automatically opts intoyour preferred method of getting rewarded, be it cash back or travel points,when you pay and redeem rewards? What if you received automatic budget alerts for spending on electronics when you either physically or virtually entered an Apple retail store? What if you never had to present your ID ever again to enter a bar or pay with your credit card? Dan invites us to imaginea world without friction, where banking is not an act or a destination but an enabler of everything that we do.

To achieve that vision, new and incumbent players in the fi nancial ser-vices industry will need to collaborate, integrate, and innovate together. Noone understands these types of partnerships better than Dan. One of the most clear themes of Dan’s career—and, I would argue, one of the mostimportant lessons for fi nancial institutions looking to stay relevant to theircustomers—is the enlightened idea that banks should seek to actively part-ner with technology companies with complementary business models.

Dan weaves this point throughout the book with powerful examples, including the Mastercard‐branded Google Wallet card and the Yodlee plat-form for a host of personal fi nancial management tools. At Lending Club, we made the decision to partner and work with banks rather than viewing them as competition. We recognized that banks have competitive advantag-es in their low cost of capital and pre‐existing customer relationships, whilewe can deliver a better customer experience at a lower cost. This creates theopportunity to partner, with traditional banks working with innovators for the good of the customer. History has shown that major innovations tend to come from outside the banking industry. It will be up to banks to decidewhether they will open themselves up to innovation that will better serve their customers, and it will be up to technology companies to work con-structively with incumbents.

With Virtual Banking: A Guide To Innovation and Partnering , Dantakes us on a journey through the technological advances occurring in thespace today that every banker, investor, entrepreneur, and industry pro-fessional could benefi t from. His rich anecdotes and interviews make it acolorful, entertaining read. Disruption in fi nance through technology is a complex subject, but Dan simplifi es it and more importantly he encouragesus–no, challenges us–to think differently about it.

xv

Preface Preface

You guys are the enemy!” As head of fi nancial innovations for PayPal, I heard that pretty often in my fi rst few years at PayPal. Even prior to

my time at PayPal, when I headed the retail payments practice for fi nancial research and consulting company Celent, I heard it regularly from my bank clients: “How should we think about PayPal, Google, Facebook, Apple, orany other institution innovating in the fi nancial services space? Will they eatour lunch? What about the emerging start‐ups that are getting into bank-ing services without becoming banks?” More than once, I told myself that somebody should write a book on what’s really happening in the world of tech and fi nancial services—the fact that if you really peeled back the onion a few layers, what you would fi nd is that co‐opetition does exist, everyone is working out deals behind the scenes, and massive opportunities exist for banks to partner with nontraditional players. Many of the new partnerships forming are blueprints that give a glimpse into future fi nancial services inno-vation and some really compelling customer experiences to come. You justwouldn’t know it from the media hype that loves drama! In fact, it’s com-panies like PayPal and the many innovative fi nancial technology start‐ups that are opening new opportunities for the banking industry, expanding theopportunity pie and keeping the fi nancial services community more relevant to changing customer preferences, new technology trends, and signifi cantly increased customer expectations.

As a professional running virtually any service for your retail bank, how can you position your institution to become a customer magnet instead of a repellent? Part of the answer lies in creative deal making, Silicon Valley style. New technologies and platforms are now available on a wide scale and those fi nancial institutions who can strike deals with nonbanks can meet their regulatory requirements while offering valuable new experiences that consumers will happily pay for. Even more important, the right partnerships will not only help banks meet their requirements, it will make banks more competitive in “the new normal.” I defi ne the New Normal as an environ-ment in which many nonfi nancial entities are now entering the fi nancial space and fi nding ways to attract customers with no branches, no check-books, or other brick-and-mortar services, historically seen as “must‐haves”

“

xvi PREFACE

to attract customers. Banks must learn what they can outsource and whatmust remain a key part of their offering in order to compete and thrive in this environment.

This book is intended for those who would like to understand how to innovate and drive signifi cant positive change in their organization though cre-ative partnering. These opportunities to collaborate haven’t always existed—it’s a result of a unique collision of trends—today’s ubiquity of the Internet and smartphones, the rise of open platforms and application programming inter-faces (APIs), the growth of new commerce brought by social, local, and digital capabilities, network effects, and a fundamental change occurring in consumer expectations. This is meant to serve as a guide on how to exploit these trends to further innovation, whether you are part of a large bank, small bank, fi nancial technology provider, or someone who would like to understand better how in-novations in banking and payments can be shaped through the use of creative partnering.

As a member of the fi rst large‐scale payments company to make the shift to platform services, and to witness the tremendous amount of creativepartnering that was happening, it became increasingly clear to me that what was holding fi nancial services industry back from unleashing moreinnovation were really two things—a lack of focus on creative partnering, and a good understanding of the major technology and consumer shifts that have precipitated the needs for these major business model changes to occur. At PayPal, within a few short years, we went from no fi nancial institu-tion partnerships to several hundred, generating over $1 billion in paymentvolume. The opportunity for our bank partners to take advantage of PayPal platform capabilities for their own customers to generate new value was sig-nifi cant, and I realized that there was a macro trend taking shape—one that would allow the fi nancial community to take advantage of open platforms and partnerships like never before to spur a new wave of innovation and value for their customers.

In light of many of the signifi cant industry shifts happening—consumer expectations around commerce, the growth of mobile, the network effects of social commerce, it has never been more important to understand and an-ticipate what consumer expect from fi nancial services fi rms in order to meet their needs. What often ends up happening is an inside‐out approach to thinking about what’s best for the customer—something I call “the military industrial complex of payments”—large technology departments at banks who advocate for continual proprietary development work that could be done in a more user friendly fashion, done cheaper and more effi ciently by outside parties who listen more closely to the market. These insular projectsoften end up costing banks far more than money or time—they end up con-fusing large technology projects with true customer‐focused “innovation”

Preface xvii

and doesn’t end up solving a consumer pain point and usually disappoints. Too often, the fi rst thought is to build a product, leverage a standard bank-ing vendor, or engage in a coalition with other banks to build a common framework or utility. While that approach has worked well to create util-ity services—standard credit card and automated teller machine (ATM) networks—it works less well when it comes to differentiating product or service offerings, which is a must in order to stay relevant with customers. Instead, why not think “partner” before “build” or “buy,” particularly in today’s environment when there are so many companies with such a strong history of design and product innovation.

Financial services innovation often implies heavy investments in technology or operational process, which may or may not lead to positive, transformative change. Real innovation can be very low cost and leverage existing technology assets and processes, but it can often come in the form of creative partner-ships that aren’t always obvious on the surface. An untapped opportunity exists between the tech world and the fi nancial world, which can work together to achieve more than they could separately.

I hope this book will provide you with a very hands‐on approach to how banks can innovate and thrive by partnering and imitating the ap-proach of some of the cutting‐edge incumbent banks, technology providers, and other thought leaders.

Dan Schatt April 2014

xix

Acknowledgments Acknowledgments

The original inspiration for this book really came as a result of my ex-perience with the founding fi nancial innovations team at PayPal—the

most innovative, passionate, unstoppable folks out there who exemplify talent and teamwork: Arkady Fridman, Mamta Narain, Peter Amalraj,Katherine Wilson, Kareem Al‐Bassam, Jeroen Van Son, Jonathan Knoll, Fred Alexander, and Maksim Rohkline. Thank you all for proving that a small group of people can make a huge impact in shaping the fi nancial serviceslandscape and demonstrating to banks that technology companies make worthy partners.

The latest and continued inspiration for this book has come from my partners at Stockpile, Inc., an exceptional group of people who are building the fi rst ever “PayPal” for stock. A sincere thanks to Avi Lele and Sanjeev Kulkarni for their pioneering work in this area. It will most defi nitely havea signifi cant impact on global fi nancial inclusion.

I’ve been very fortunate to have numerous mentors along the way that without whom this book would not have been possible. A very big thank you to Scott Thompson, former president of PayPal. Scott is one of the best leaders I’ve had the pleasure to work with, a friend, a mentor, and a real innova-tor responsible for PayPal’s largest innovations to date. Thank you to Alenka Grealish, who is responsible for my becoming an industry analyst with Celent, for helping me develop those analyst skills necessary to go below the surface and dig out those valuable insights! Thank you to Noel Kullavanijaya, for whom I had the pleasure of working at Citigroup and who has been extreme-ly generous with his time, guidance, and friendship over the years. Thank you to Osama Bedier, a true inspiration to work with and a great big‐picture thinker. Thank you to Matthew Mengerink for your guidance at PayPal, your insights for this book, and your never‐ending energy.

Thank you to the highly talented contributors in the book—George Peabody of Glenbrook for authoring the chapter on math‐based currencies, which is fi lled with interesting observations. Matt Harris—thank you for your very well‐written piece on prepaid and your valuable perspective on trends in fi nancial technology. Paul Steencamp, a real innovator formerly with First National Bank of South Africa, and Warren Bond, CEO and

xx ACKNOWLEDGMENTS

founder of Luminous, were also extremely helpful in outlining the manypractical examples of how banks and start‐ups can work together. Anotherbig thanks to Neil Hiltz at Facebook, who put together a very thoughtful piece on how banks can take advantage of social trends, and Julie Ruggierofor helping with all the necessary approvals. I’d also like to express myappreciation to Peter Aceto and Charaka Kithulegoda, CEO and CIO of ING Direct Canada for their terrifi c contribution that discusses how they have successfully driven innovation at their bank, and to Aline Badr for put-ting it all together. JP Nicols, thank you for your encouragement, introduc-tions, and contribution to how banks can think about partnering. A very big thanks to Anil Arora, Melanie Flanagan, Joe Poverari, and Eric Conners atYodlee, who continue to push the envelope on bank innovation and always offer valuable thoughts for the fi nancial services industry.

Thank you to the many thought leaders who agreed to be interviewed for this book: Hans Morris for the always insightful, relevant, and thought-ful feedback on fi nancial services and payments; Russell Goldsmith, CEO, and Nate Wehunt, head of Digital at City National Bank; Bill Ready, of Braintree; Sergi Herrero of BNPP; Zilvinas Bareisis of Celent; and Dana Stalder at Matrix. Renaud Laplanche, CEO of Lending Club—thank youfor sharing your insights on peer‐to‐peer lending and how banks might par-ticipate. Meyer Malka of Ribbit Capital—thank you for giving me a brand new perspective on Bitcoin and for your very unique and valuable perspec-tives on fi nancial technology. I am also appreciative of Mike Strange, CTO of Mitek, for his contribution and insight for banks in how they might in-vest in their ecosystem. Brett King, author of Bank 3.0—thank you for yourinnumerable insights on book writing and your support. Chris Popple of RBS Bank—thank you for contributing your thoughts and time. Thanks toJohn Staley, COO of Equity Bank, who has opened my eyes to the manyfi nancial innovations taking place across Africa.

I want to thank the many industry colleagues and partners who have helped shape this book directly and indirectly through their insights, anec-dotes, and content. Jim Bruene, founder and CEO of Online Banking Report and the Finovate conference—thank you for offering so much rich content, introductions, and encouragement during this process. John Schulte, CIO of Mercantile Bank of Michigan—a true thought leader and visionary—thank you for having your bank become the fi rst bank to partner with PayPal for person‐to‐person payments and all of your excellent perspective. Carl Scheible, EVP at MoneyGram—a very big thank you for your collaboration and pro-viding such rich material on behalf of MoneyGram. Thank you to John Val-entine at LevelUp for pointing me to some great industry and media sources. Thank you to Chris Larson, Patrick Griffi n, and Danny Aranda at Ripple for your contribution and support in researching math‐based currencies. Danny

Acknowledgments xxi

Shader and Billy Robins at PayNearMe—thank you for the strong content you’ve contributed and the insights into how banks can work with nontra-ditional partners. Thank you to John Hurley and Darian Shirazi, founder of Radius, for the unique data and insight you have made available for the book. Scott Dunlap, founder of 10th Dimension—thank you for your insightful contributions and quotes. Thank you to Shamir Karkal and Krista Berlincourt of Simple (now BBVA) for taking the time to discuss your company with me. I also want to thank Sarah Friar at Square for taking the time to discuss Square and sending me $1. May Meere and Ericson Chan of Standard Chartered—thank you for offering new perspectives on some of the challenges and op-portunities in Asia. Thank you to David Greene at Technology Credit Union, one of the fi rst movers to partner with PayPal and offer a unique perspective on partnering. Mike Boush, thank you for your support and for demonstrat-ing that sometimes big card issuers can act like nimble start-ups. Thank you to Andy Spindler of FSVC for lending your perspective and the always unique vantage point on fi nancial services in the emerging markets. I also want to thank Jenny Ceran, a trusted friend and former PayPal colleague, for all the support, encouragement, and terrifi c ideas along the way.

Several friends and colleagues from the research and consulting com-munity were also instrumental to this book. To Daniel Wolfe, editor‐in‐chief at PaymentSource—I always learn something from every conversation we have. Thank you to Zachary Aron and the Deloitte fi nancial services team for lending your time to offer your thoughts for the book. Thanks to Steve Mott at BetterBuyDesign, always an original thinker and a highly respected industry colleague. Also thanks to Jane Hennessy and Chuck Adams for the many suggestions and articles you’ve shared. I also appreciate the time and insights from my former analyst colleagues—thanks to Zil at Celent and Gwenn Bezard at Aite for your terrifi c insights.

I am very thankful to the editors at Wiley Finance—thank you to Susan McDermott and Bill Falloon, who sought me out and enlisted me on this adventure. Thank you very much to Judy Howarth, who painstakingly went through this manuscript and offered innumerable contributions to make the book better. Thank you to Vincent Nordhaus for running a tight ship withthe production schedule, and to Katie McGowan for all of your creativedistribution ideas. Thanks to Tiffany Charbonier for your support with thevarious marketing and administrative work for this book.

Last, but never least, to my wife and best friend over the past 22 years, Suzan Negip Schatt, who has been a true partner, comfortable with my leav-ing PayPal to write a book without the future mapped out, and just as com-fortable with exploring the unknown on our fourth continent together as when we met. She is the uncommon master of common sense whose good judgment, humor, and patience deserves an entire book of praise.