Who Will Win the Web 2.0 Payment Wars?

Call it micro-payments, social networking payments, virtual currency, or whatever you like, but speculation is heating up as to who will develop a service that addresses Web 2.0’s payment needs.

PayPal claimed this mantle for the first incarnation of the internet. As I detailed in The PayPal Wars, when Peter Thiel, Max Levchin, David Sacks, Reid Hoffman, and the rest of our executive team made the decision in January 2000 to build our payments network on top of eBay’s ecosystem of buyers and sellers, we outflanked our competitors and identified the path that would let us scale to profitability. In doing so, our startup beat out Yahoo, Citibank, and even eBay itself (which jointly owned Billpoint with Wells Fargo) to become the de facto standard for selling goods online.

But the payment needs of the social web are different. Goods are generally virtual or content-related, and the transaction amounts are often small. (For example, Slide charges a $1 for premium SuperPoke actions, or gives you unlimited quantity for $4.99 per month. Contrast this with the $50 average transaction price we saw at PayPal.) Also, any payment solution would need to be tightly integrated with the social network it’s serving.

The need for social payments is growing. Case in point, Dan Gillmor asserts on his blog Mediactive that YouTube Direct (YouTube’s platform to let news organizations collect user-submitted videos) would also benefit from a payment system. Dan points out that this would allow content providers to reward their followers for providing them with monetizable content.

A couple of Twitter-centric payment services have already sprouted up; Twitpay and Twippr both leverage PayPal’s platform to allow you to tweet money. (See this Squidoo post for a helpful comparison.) TipJoy, another company that specialized in Twitter payments, is shutting down.

Of course, it’s Facebook—the most important social network site—that’s attracting a lot of attention in the payments discussion. Mashable’s Pete Cashmore writes that Facebook itself could become the micro-payment service of choice for content providers. Noting the proliferation of virtual goods on the social networking system, as well as the many media companies now participating in Facebook Connect, he concludes that Facebook (which has a beta virtual currency in beta mode) has a better chance to build this platform than PayPal, Google, or Amazon.

TwoFish’s Lisa Rutherford provided a nice overview of the marketplace a few months ago for VentureBeat. She saw PayPal, Amazon, and Google as potential players, but seems to suggest that it’s unclear if Facebook will make a full court press to dominate this space. However, it looks like that’s exactly what Facebook is doing; I’m told that they recently hired a couple of highly respected ex-PayPal guys to work on their payments team.

Facebook is certainly formidable. Nonetheless, I still think PayPal should own this space. Here are some reasons why:

First, a payments network is not easy to build. Even if you have an existing network of users that you can leverage, the back-end is a lot more difficult than a content-based service.  Fraud risk, funding costs, and customer support are all major factors that we underestimated in terms of complexity or cost as PayPal was scaling. As I noted in my book, PayPal was bleeding $10 million per month back in 2000 while we struggled to fix our business model, and that was before the company had scaled to any significant size.

Second, just because a company is good at its core business doesn’t mean it will be good at payments. Facebook is an amazing company, but that’s no guarantee that it can leverage its social leadership to build a scaleable payments network. Google hasn’t been able to do it with its Checkout feature, and despite the elegance of One Click, Amazon has never been able to get much traction with payments off its own site. If a competitor has a better product, users will opt for the competitor. The case of eBay’s own users refusing to adopt Billpoint in favor of PayPal illustrates this.

Third, non-fiat currencies aren’t an easy sell to consumers. Ask Flooz. Ask Beenz. These two early, would-be PayPal competitors occupy spots #2 and #3 on Business Pundit’s “25 Internet Startups That Bombed Miserably” list. (If not for “Startup.com,” they might’ve ousted GovWorks from the top spot.) While many people think that the time is ripe for a virtual currency, there’s no hard evidence of demand for a system of value not based on fiat money. Cash is still king, and that’s a major obstacle for companies like Facebook opting to build a virtual currency.

Fourth, the implicit assumption that a Web 2.0 payments network doesn’t need to be compatible with transactions happening in the real world is false. Backwards compatibility is important for any platform—just ask an Office 2003 user who’s received a .docx file. The utility of a payments system is immensely greater if the network encompasses not just the up-and-coming world of social/virtual transactions, but also some chunk of the $30 trillion in annual consumer payments worldwide. PayPal already moves $2200 USD per second through its servers; that’s a nice head start.

Building a payments network is difficult, and it’s not clear that Facebook or any other competitor will be able to leapfrog over PayPal and build the defining platform for Web 2.0. However, if PayPal wants to seize leadership in this space, it has a lot of work to do. We’ll explore that in a future post.