How Venmo does P2P without fees

Why playing the long game in the fiercely competitive peer-to-peer payments market pays off for Venmo

Venmo, the popular peer-to-peer payments application, and its fee structure—or lack thereof—has been subject to a fair amount of interest in recent years, especially as it has come to dominate the market, especially among millennials. But there’s no magic behind Venmo’s ability to facilitate P2P payments without charging fees to its users. No technical trick, anyway: It simply chooses to absorb these costs.

Venmo Illustration by Rob Engvall

Venmo itself—like all P2P providers—has to pay transaction fees no matter what form of payment powers the peer-to-peer exchange. That’s because Venmo is largely dependent on existing payment infrastructure—and also existing fee systems. In other words, while Venmo’s solution marked a huge step forward in peer-to-peer payments—as evidenced by its popularity, moving $1 billion in January 2016 alone—the company hasn’t invented new ways to move money. While it might feel different to consumers, especially those thankful for the lack of fees, but they’re still relying on old standards in money movement, like credit and debit card-funded transactions and bank-to-bank transfers.

So Venmo’s user fees, or lack thereof, amount to a business decision rather than a specific technical innovation. The decision was no doubt driven by the competitiveness of the P2P market, and it’s paid off: The lack of fees helped give Venmo an edge over its rival, and now-parent, PayPal, and other peer-to-peer providers. PayPal transactions made to or from a bank account or PayPal balance are free, but if payments funded by debit or credit cards—even to friends—carry a 2.9 percent transaction fee. Square Cash transactions between friends are free, but only work with debit cards.

Venmo, on the other hand, doesn’t charge fees to users who pay using their Venmo balance, bank account, or major debit cards. In these cases, Venmo pays the processing, issuing, and acquiring costs to make whole the funds sent to the receiver. The exception comes when people use a credit card or non-regulated debit card to pay their friends; in this case Venmo charges them a 3 percent fee to make up the interchange fee, or the cut credit card networks and card-issuing banks take for each purchase.

Venmo’s decision whether to charge or not to charge boils down to the fact that it costs Venmo significantly more to process payments from credit cards (and debit cards issued by smaller banks): 1 to 3 percent of the transaction value. Major debit cards, on the other hand, levy a flat fee, around $0.20 per transaction. When a bank account is connected directly to a user’s Venmo account, Venmo uses ACH processing—bank-to-bank transactions—to drive the transaction. ACH also carries only a nominal flat fee.

Because these fees are comparatively small, Venmo absorbs the costs as an incentive for more customers to join the platform. In Venmo’s case, time really is money: Consumers often prefer the speed at which credit and debit cards move payments. The primary incentive, however, is the ease with which users can move money from Venmo to their bank accounts. Well, that—and Venmo’s emojis.

For a long time, Venmo has been a money-losing proposition. But it’s built up a valuable—and pretty loyal—customer base, who used it to process $1 billion in January alone. PayPal announced in late 2015 that Venmo will follow soon enable users to pay not only their peers, but also merchants. The program is currently being piloted with meal delivery startup Munchery and sports ticketing app Gametime, two current PayPal merchants. Venmo will charge the same fees levied by PayPal: 2.9 percent of each transaction, plus 30¢.

“Merchants are very excited about this,” Joanna Lambert, PayPal’s vice president of consumer product and engineering, told Fortune in October 2015. “Venmo users post their transactions to their friends in the app, so it’s essentially a form of social advertising.”

Indeed, according to a study by Jefferies, two-thirds of users surveyed by the firm said they would use the feature, leading analysts to estimate that the feature could bring an additional 1 to 3 percent to PayPal’s 2017 sales—meaning that Venmo’s approach to competing in P2P may well pay off.

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