1. ESSAYS ON ISSUES THE FEDERAL RESERVE BANK JULY 2007
OF CHICAGO NUMBER 240
Chicago Fed Letter
Are mobile payments the smart cards of the aughts?
by Katy Jacob, research specialist
This article compares the much anticipated but ultimately stalled smart card revolution
of the 1990s with the current expansion of mobile payment platforms, and asks how
mobile payments fit into the larger payment system.
In the past few years, payment networks cards using radio frequency identifica-
and banks have begun to follow in the tion (RFID) technology. All of the major
footsteps of start-up companies and offer card networks and many large financial
mobile platforms, meaning in-person institutions have rolled out contactless
or remote payments via a mobile phone products. Some very large merchants,
or other mobile device. Is this just an- such as McDonald’s and Wal-Mart, have
other overhyped trend (like smart cards invested in RFID infrastructure. More
in the 1990s), a real payments revolu- than 40,000 U.S. merchant locations ac-
tion, or something in between? In short, cept contactless payments. Analysts esti-
are mobile payments the smart cards mate that there are 27 million contactless
Mobile commerce is predicted of this decade? cards in the U.S. today.1 Eleven years
to grow exponentially in the after the first major trial, smart cards
During the 1990s, payments industry
finally seem to be gaining some traction.
marketplace. Some analysts analysts, policymakers, and academics
predict that, globally, mobile predicted an eminent “smart card In the current decade, a new payments
revolution” as providers began to use revolution is being hyped that combines
payments will be worth
closed-loop trials and focus groups to two subsets of mobile commerce—mobile
$55 billion in 2008. test different types of cards. Smart cards payments and mobile banking. Mobile
look like credit cards but utilize a micro- payments are defined as “any payment
chip to store identification and trans- where a mobile device is used to acti-
action information. The most famous vate and/or confirm the payment.”2 A
smart card trial was the 1996 Olympic variety of solution providers, payments
Games, when Visa developed a smart processors, and other institutions can
card for use at 1,500 merchants inside offer mobile payments. Mobile banking,
Atlanta’s Olympic stadium. Consumers on the other hand, remains the exclu-
were not inclined to embrace smart cards, sive domain of financial institutions that
given the other payment options avail- have a deposit relationship with a con-
able, especially because they were accept- sumer. While mobile banking services
ed in only a limited number of locations. can enable mobile payments, the re-
Smart cards never took off in the gen- verse is not true.
eral marketplace during the 1990s, and
Each subset of mobile commerce is pre-
they remained in the trial phase because
dicted to grow exponentially in the mar-
of ongoing challenges related to infra-
ketplace. Some analysts predict that,
structure, marketing, standardization,
globally, mobile payments will be worth
and profitability.
$55 billion in 2008.3 But as with smart
A decade later, we are just beginning cards, while mobile payments have gained
to see the adoption of contactless chip ground in Asia and Europe, they have

2. not in the U.S. There are a number communication (NFC) technology is To be successful, any new payment form
of reasons for this, including regu- built into the phone.4 The other option needs a large customer base and a high
latory, market, technological, and integrates payments into the phone’s volume of transactions. The mere preva-
cultural differences. First of all, the software, enabling a consumer to use lence of mobile phones does not neces-
existing electronic payments infra- the phone as a virtual “mobile wallet.” sarily mean that enough consumers will
structure in the U.S. is expensive to For in-person or proximity payments, embrace them as payment instruments.
replace, especially for merchants. consumers use the phone to make a pur- Mobile payments are in their infancy,
In some cases, countries with less chase at a point-of-sale terminal that is and while consumers currently see their
developed electronic payment sys- equipped to handle the payment. Remote potential value, it is difficult to gauge
tems have been able to move more payments utilize SMS, wireless application their inherent value. Research suggests
that consumers need more exposure to
mobile payments possibilities before we
Research suggests that consumers need more exposure to can understand the factors driving adop-
tion. Because of its high mobile phone
mobile payments possibilities before we can understand the usage, the youth market has been touted
factors driving adoption. as the cohort that will catapult mobile
payments into the financial mainstream.
One survey found that, in the past year,
quickly into mobile payments. More- protocol (WAP),5 or a proprietary solu-
more than 10% of respondents made a
over, in some developing economies, tion integrated into the phone’s soft-
purchase with a mobile phone, while a
such as those in the Caribbean and ware to initiate payments that do not
slightly higher number made a person-
South Africa, the lack of telephone require a point-of-sale terminal.
to-person (P2P) payment with a mobile
land lines brought more consumers
Many mobile trials in the U.S. have fo- device. The same survey found that those
into the mobile market faster.
cused on remote payments, and some aged under 25 purchase digital con-
At the same time, the U.S. wireless financial services companies have be- tent for their phones, while those aged
market is fairly atypical in the world gun to relay financial information to 25–34 are more likely to use phones to
in its complexity. There is no one set customers using SMS. Some trials have transfer funds.7
of standards for the high number of utilized a chip-based model. In order
Importantly, although mobile payments
firms and networks involved in the to provide banking functionality, such
represent another payment choice for
wireless market, which can impede in- as account balance checks, consumer
consumers—who are estimated to make
novation and interoperability in dif- alerts, and payment verification, most
58 individual payment choices each
ferent areas of the country. In Japan, providers use an Internet-browser-based
month—these payments often rely on
on the other hand, NTT DoCoMo solution or proprietary software to con-
traditional funding and settlement sys-
is dominant in the mobile market nect to the bank’s network. Depending
tems.8 In fact, many current U.S. mobile
and was able to use its very large mar- on the structure, both proximity and
payment trials, especially those focused
ket share to influence merchants and remote payments might require a con-
on proximity payments, are dependent on
financial services companies. Further, sumer to be connected to the financial
the existing magnetic-stripe-card-based
this telecommunications company system in some way, through a deposit
infrastructure. In these cases, the mobile
also directly owns its own payment account, credit card account, or debit
phone becomes a device through which
platforms to facilitate commerce, card account. The advent of prepaid
consumers access payment card accounts,
which would generally be a more cards, however, enables some consum-
and arguably, no real payment substitu-
difficult proposition within the reg- ers to access these types of mobile pay-
tion takes place. On the other hand, at
ulatory environment in the U.S. In ments without having bank accounts
some point in the future, a chip placed
addition, largely because of legacy or credit histories.6
in a phone or another device could be-
pricing structures, American consum-
come the primary way that consumers
ers have been slower to adopt short The promise of mobile payments
access credit or prepaid accounts, elimi-
messaging service (SMS) communi- The number one reason given for the
nating the need for a physical card.
cation (mobile phone text messaging) predicted rise of mobile payments is the
than their counterparts overseas, prevalence of mobile phones coupled Payment trials and tribulations
and SMS is a critical part of many with consumers’ willingness to adopt
There is a parallel between today’s mo-
mobile payment systems. new mobile functionality. Globally, there
bile payment trials and the smart card
are over 2.5 billion mobile phone users,
trials of the 1990s. Analysts agree that our
How do mobile payments work? surpassing Internet or personal com-
legacy payments infrastructure represents
There are two ways to think about puter users. In the U.S., there are more
one of the biggest obstacles to mobile pay-
mobile payments. One involves the than 230 million wireless subscribers,
ments. Because these new payment sys-
phone as a chip carrier, wherein a and there are high users of mobile
tems have had limited exposure, there
computer chip using near field phones across all income levels.

3. is a lack of large-scale data sets to facilitate a reality. Obviously, telecommunications Because of the efficient electronic pay-
comparisons with other payment forms. firms have a significant role to play, as ment mechanisms in the U.S., main-
It is also difficult to infer U.S. usage from do software and hardware companies, stream consumers might be interested
international experience because of banks, merchants, and networks. Because in mobile payments for reasons beyond
market differences, as discussed earlier. of the large number of players, analysts payments per se. It is not always necessary
Understandably, companies involved question who will be “in charge” of mo- to be able to pay for anything from any-
in limited trials are unwilling to make bile payments in the future: Who will where anytime, but consumers might
significant infrastructure investments deal directly with the customer, absorb find great utility in being able to send
when it is not clear how consumers will the risk, pay for the infrastructure, and and receive financial information from
react. Payment providers also typically foster innovation? And how will revenues the same device that they use to make
assume that merchants will bear the costs be divided to ensure that the cost to payments. As behavioral economists are
of the new infrastructure, while mer- the consumer is sufficiently attractive? quick to point out, many consumers like
chants need to be convinced of the ben- to budget their purchases. One of the
Some analysts argue that banks play the
efits accruing to them before making benefits of using mobile payments is that
most crucial role in the equation and
such investments. it facilitates recordkeeping to help con-
that mobile payments will never truly take
sumers stay within budget. For example,
Ironically, it is in part due to the ways off without an effective mobile banking
some prepaid card companies have be-
that the smart card and mobile payment platform. But this is one payment form
gun offering a text message service to
trials have been developed that it is dif- that banks can’t exclusively dominate.
consumers who would like to be notified
ficult to gauge consumers’ adoption of They need the cooperation of phone
of each transaction. This type of real-time
the new payment methods. Most of these companies that are looking for new ways
account recordkeeping can be especially
trials have occurred in closed-loop or to differentiate themselves in a crowded
beneficial for consumers with low bal-
limited-scope systems and, by definition, market. As banks compete with each oth-
ances or those who are sharing accounts
test only one distribution method (phone er for similar customers, so do phone
with family members.10 Moreover, mer-
or card) rather than several simultaneous- companies. However, they are not neces-
chants can derive value from the infor-
ly. When consumers are out of the “trial sarily vying for the same set of customers.
mation exchange made possible through
zone” or away from areas that allow re- Mobile companies have high penetration
the mobile phone or device by devel-
mote payment functionality, they are not rates among unbanked and lower-income
oping loyalty programs and targeted
able to use the payment devices. In the households whom banks find hard to
marketing campaigns.
1990s, limited consumer appetite, infra- reach, while phone companies might be
structure costs, and uncertainty over able to lure higher-income customers It is this interconnected functionality that
issues such as standards, security, and who would be willing to switch from makes mobile payments unique. A mo-
customer relationships kept companies Internet payments to mobile payments. bile payments platform can integrate
from moving forward with their smart
card plans. Is there a “killer” mobile application?
Mobile holds a significant advantage Michael H. Moskow, President; Charles L. Evans,
There is now a synergy between the mo- Senior Vice President and Director of Research; Douglas
over contactless cards in the area of Evanoff, Vice President, financial studies; Jonas Fisher,
bile and chip worlds. As multiple mobile
paperless two-way communication. Economic Advisor and Team Leader, macroeconomic
payment trials are in process, there are policy research; Richard Porter, Vice President, payment
Card-based models do not allow for
also an increasing number of chip-based studies; Daniel Sullivan, Vice President, microeconomic
the sending, receiving, and presenting policy research; William Testa, Vice President, regional
card trials among major firms. Thus, mo- programs and Economics Editor; Helen O’D. Koshy,
of information, as mobile devices do.
bile payments are not rising up in a vac- Kathryn Moran, and Han Y. Choi, Editors; Rita
Internet payments made via personal Molloy and Julia Baker, Production Editors.
uum—RFID/NFC chip platforms are
computer are most similar to mobile Chicago Fed Letter is published monthly by the
simultaneously gaining ground as the net-
payments in this regard, but currently Research Department of the Federal Reserve
works and large financial institutions ten- Bank of Chicago. The views expressed are the
require more cumbersome hardware.
tatively accept the possibility of moving authors’ and are not necessarily those of the
As we enter the age of the Apple iPhone Federal Reserve Bank of Chicago or the Federal
to chip-based payments. For example, Reserve System.
and similar devices, it becomes clear
Wal-Mart’s decision to require its top
that mobile phones now have the ability © 2007 Federal Reserve Bank of Chicago
suppliers to put RFID tags on shipping Chicago Fed Letter articles may be reproduced in
to operate as small-scale computers. whole or in part, provided the articles are not
crates has been influential, even though
Some mobile payment platforms involve reproduced or distributed for commercial gain
some suppliers balked at the $0.25 to and provided the source is appropriately credited.
specific downloaded software, and NFC
$0.30 cost per tag. Further, the existing Prior written permission must be obtained for
chips can carry a substantial amount any other reproduction, distribution, republica-
RFID infrastructure at the merchant tion, or creation of derivative works of Chicago Fed
of data. Moreover, as technology ad-
level, while small, reduces a key initial Letter articles. To request permission, please contact
vances with innovations such as WiMAX,9 Helen Koshy, senior editor, at 312-322-5830 or
hurdle for mobile payments adoption.
Internet connections through mobile email Helen.Koshy@chi.frb.org. Chicago Fed
Multiple industries are needed to make Letter and other Bank publications are available
devices will become faster and more on the Bank’s website at www.chicagofed.org.
a new mobile payments infrastructure readily available.
ISSN 0895-0164

4. payments, banking, and real-time two- Surveys show that consumers would pre- is potential to avoid the pitfalls of the past
way data transmission. The same cannot fer to receive mobile payment offers from experience with smart cards in devel-
be said of cash, checks, or cards. How- banks rather than third party processors oping a robust business model around
ever, most mobile trials have been siloed or phone carriers, perhaps because of mobile payments.
into remote payment pilots that direct security concerns or familiarity.11 The
It is important to note that while the mo-
consumers through existing payment incorporation of successful security mea-
bile phone might be the most obvious
networks and utilize SMS to relate infor- sures that are not burdensome will be
initial channel for large-scale adoption
mation or chip-based trials that enable important to mobile payment business
of a new payments infrastructure, it need
proximity payments. A “killer” applica- models. Companies that can capitalize on
not be the only channel—unless the
tion might allow consumers to use both, a “trusted source” reputation might ulti-
infrastructure that is eventually built is
as well as provide recordkeeping soft- mately be more successful in this space.
specific to one form of payment. In the
ware for budgeting purposes and oth-
Conclusion future, we may look back and see that
er appealing features that consumers
the specific focus on mobile phones or
would embrace. Today, smart cards, which debuted un-
smart cards was limited in scope. A new
successfully in the 1990s, and mobile
Unfortunately, the very aspect of mobile payments evolution may be realized by
payments are gaining popularity simul-
payments that makes them appealing a nexus of networks, financial institutions,
taneously as payment providers seek to
carries risk. While firms can use two- and technology providers that can en-
capitalize on the information-sharing
way authentication and other security sure a safe, reliable, convenient, and
capabilities of mobile and chip-based
measures, consumers and merchants ubiquitous chip-based payment platform—
payments that are not available in paper
might be wary of mobile payments in a be it via a mobile phone, RFID tag,
or magnetic stripe payments. Due to the
system where data are broadcast over contactless card, or another, as yet un-
many ways that mobile phones are in-
airwaves and are at risk of interception. foreseen, payment instrument.
tegrated into consumers’ daily lives, there
1
Packaged Facts, 2007, Smart Cards in the application is to enable Internet access provide wireless data over long distances,
U.S.: Contactless Payment Cards, report, from a mobile device. in a variety of ways. J. Van, 2007, “Taking
Rockville, MD, May 1. 6
Prepaid cards are prefunded, with monetary wireless to the WiMAX,” Chicago Tribune,
2
S. Karnouskos and F. Fokus, 2004, “Mobile value recorded on a magnetic stripe. In the April 12, p. 1.
10
payment: A journey through existing pro- case of open-system cards, such prepaid K. Jacob and C. Boyd, 2007, “Mobile finan-
cedures and standardization initiatives,” cards can be used on the existing card net- cial services and the underbanked: Oppor-
IEEE Communications Surveys and Tutorials, works in the U.S. and elsewhere. tunities and challenges for mbanking and
Vol. 6, No. 4, pp. 44–66. 7
Financial Insights, 2007, Financial Insights mpayments,” Center for Financial Services
3
Celent LLC, 2006, “Mobile commerce: 2007 Consumer Payment Survey, report, Innovation, report, April.
11
Dealing with the devil in the details,” Framingham, MA, April. CheckFree Corp. and Firethorn Holdings
report, San Francisco, CA, February 13. 8
American Bankers Association and Dove LLC, 2006, “CheckFree and Firethorn part-
4
Some solution providers have also placed Consulting, 2005, 2005/2006 Study of ner to deliver mobile banking and bill pay-
RFID tags on the phone’s memory card to Consumer Payment Preferences, report, ment services for financial institutions,”
enable proximity payments. Washington, DC, October. press release, Atlanta, GA, November 9.
5 9
WAP is an open, international wireless WiMAX is defined as Worldwide Interoper-
communication standard, whose principal ability for Microwave Access and aims to