When starting a business, one of the first questions to ask is how it will make money. It obviously follows to know how the money will get from Point A to Point B. But while the mechanics of payments are often tangled into the business model, many companies don’t actually need to control the movement of money. At the end of the day, the process just needs to be simple. And Etsy, Airbnb, and Uber—and countless other companies—have discovered, regulations can make the process anything but simple.
Many technology companies naturally tend to be developer-centric. This can foster an environment that prizes building new solutions over buying existing ones. And payments can often look like a worthy area of focus: After all, too often, payments introduce that old enemy: friction. In businesses where every conversion counts, drop-off during checkout due to loading errors, complicated flows, or processes not optimized for mobile can be problematic. But the minute a business decides to start shifting piles of money itself, it earns a dubious distinction. It’s a money transmitter, subject to attendant regulations from both federal and state governments, burdensome record-keeping, and massive fees—nevermind whatever rules accompanied its core business in the first place.
Tram Nguyen
This is the part where, as an entrepreneur, it’s important to ask whether it’s really, truly essential to be at the center of—and driving—the funds flow. Practically speaking, this means that instead of relying on a third party to process bank-to-bank or credit card payments, the business holds and transfers the money. There are certain positives to transmitting money; for example, if payment volume is so great that it’s helpful to save money on fees, if control processing is a critical business function, if developing lasting relationships with payments regulators is top of mind, or friction is an especially major concern. (This last element, though, is arguably being well addressed by advances in third-party financial technologies.)
There are also business model considerations. If transmitting money isn’t core to the business, then the whole enterprise might ultimately be a major distraction from actual revenue drivers and primary innovations. Because money transmission involves such sensitive data and systems, it comes with significant regulatory burdens. And when playing against incumbents in any space, legal and regulatory holes are among the first things foes will flag.
What’s more, money transmission definitions are vague enough that they could be interpreted to cover practically any commercial situation in which money is transferred. So money transmitters are a diverse group. The likes of MoneyGram, PayPal, Western Union, Sharemoney, Xoom, TransferWise, Transfast, and Venmo are all money service businesses that transmit money—no surprises there. But Airbnb and Amazon—businesses whose primary value proposition, one might safely argue, doesn’t have to do with the transfer of money—also have licenses.
Let’s unpack the broader implications of money transmission.
What the regulations say
According to the MSB Rule, which was issued by the U.S. Department of the Treasury’s Financial Crimes Enforcement Network in 2011, anyone who provides money transmission services or engages in the transfer of funds is a money transmitter. FinCEN’s origins are in the Bank Secrecy Act, which requires money service businesses to help prevent money laundering. (A word to the wise: All money transmitters are money service businesses, but not all money service businesses are necessarily transmitters. Consider it one of the finance world’s square vs. rectangle distinctions.)
This classification draws business regulations from both federal and state-wide authorities. FinCEN requires MSBs to register as such. MSBs are further regulated by 48 states in order to protect their residents from money loss, but the laws vary from one state to another. Recently, the Conference of State Bank Supervisors created a National Multi-State Licensing System, which states use to share information and track licenses.
Anecdotally, many businesses report that it takes between a year or two to secure all the licenses—not to mention the requirements around compliance, audits, and fees. In some cases, companies have to post $750,000 or more in surety bonds.
Classification issues came to a head about five years ago, when the California Money Transmission Act became law and companies (mostly startups) that had placed themselves at the center of the payments process faced uncertainty around where they stood in the payments ecosystem.
The law essentially combined three previous financial institution–related regulations and laid down new ground rules for entities transmitting money domestically. Before that, California had regulated only money transmitters dealing with international funds. To complicate matters, the MTA was sponsored by a financial industry lobbying group that included American Express, Western Union, Travelex, and MoneyGram—businesses with some skin in the game.
It marked a turning point for many startups touching money more directly, when Airbnb buckled down and got its licenses, and Square was fined $507,000 because it lacked proper licensing in Florida. The FinCEN website lends amusing evidence to the idea that businesses lack clarity around the distinctions between MSBs and those that do more run-of-the-mill payments acceptance. Numerous resources are available, including one aptly titled “Am I an MSB?”
The landscape has continued to change since then. In 2014, for example, nearly 20 new pieces of legislation were passed that impact money transmission. California, too, passed amendments to exempt certain companies via so-called payee exemptions. In this model, a merchant contracts with an intermediary like a payment processor, which receives funds from customers on the merchant’s behalf. But only four states, California, New York, Nevada, and Ohio, have such exemptions.
Alternatively, companies can partner with licensed money transmitters to obtain payments services, making the company a licensed delegate. But this path also remains somewhat murky, as regulators and others have expressed concern that this could constitute a slippery slope or “rent-a-license” environment.
One of the best primers on the history of these rules—and the future—can be found from Bryan Cave
The companies
It’s no secret that major platform innovations are often accompanied by some sort of progress in payments. Take eBay—and PayPal. Flipkart and cash-on-delivery. No one wants to transact with a virtual bazaar that makes it harder to pay than old-fashioned barter, which is why many marketplaces have developed payments innovations.
To illustrate, let’s look at the cases of several modern marketplaces.
How Etsy evolved
When Etsy, the peer-to-peer ecommerce website with a focus on handmade goods, was founded in 2005, it didn’t have a payment method built in, leaving sellers to transact independently (and leading to something dubbed PayPal creep, where people used personal PayPal accounts on the platform). Its business model was pretty simple: Marketplace revenue, comprising a $0.20 listing fee for each item and a 3.5-percent fee for completed sales; and other revenue from seller services like advertising, discounted shipping labels, and so on.
Today, that other bucket also includes payment processing.
Etsy didn’t announce its own payment system, Direct Checkout, until 2012—a time when it was processing more than two million items and more than $46.4 million in goods a month. In other words, well after the core business was established. Direct Checkout enabled the use of credit cards, debit cards, Etsy Gift Cards, Google Wallet, Apple Pay, and PayPal. Sellers also had the option to accept checks, money orders, or other methods. When people choose to pay via Direct Checkout, Etsy charges the seller a payment processing fee of 3 percent + $0.25 per transaction. Etsy applies this fee to the total sales price, in addition to that existing 3.5-percent transaction fee, all of which are deducted prior to deposit.
Uber’s approach to frictionless payments
Uber’s approach to payments has long been considered revolutionary because it makes them virtually invisible. After initial setup—in which the customer creates an account connected to a bank account—Uber essentially eliminates the checkout process, eliminating friction at the end of the ride (and even between friends sharing a ride).
Its scale is massive: Uber reached an estimated $10 billion in global ride payments in 2015, according to Reuters.
But Uber is not classified as a money transmitter because its customers pay Uber—as opposed to paying their drivers directly. Uber, in turn, pays its independent contractors. The distinction may seem subtle, but this model makes Uber no different than the way contractors are paid at any other company. The service is rendered by Uber, not the driver.
Airbnb’s tricky regulatory tangle
Founded in August 2008, the Airbnb marketplace connects homeowners and travelers for short-term rentals. Since inception, Airbnb has faced an especially tangled web of regulations and taxes, drawing scrutiny from housing officials and hotel and lodging lobbies—and financial services regulators.
A 2012 series of articles in Business Insider spelled out its dilemma: It moves money around to pay hosts, who aren't employees, in a transactional way. This approach, it argued to hotel lobbyists, made it a technology company—not a hotel provider. But that prompted questions around what, exactly, made them different from a money transmitter.
Airbnb collects payments from guests, charges them a service fee, and transmits funds to the host—less a 3-percent fee that covers payment processing costs. Airbnb's approach marks a big difference between it and one of its major competitors, VRBO. While Airbnb makes it possible to accept payments through the service, VRBO merely offers tools for the hosts of independent businesses. It doesn’t make money on processing transactions.
Regulations around money transmission are serious business. After all, transmitting money is serious business.
Regardless, the party that transmits the funds must be subject to regulation. It’s just up to businesses to decide whether they need to be that party—and to approach the situation with thoughtfulness and care.
