This is part three of American Banker's four-part series on disruption in the payments industry. Read part one
There's a lot of innovation happening in
For example, a digital wallet called Zeal, which is launching in Europe, promises to securely hold diverse types of assets with free crypto transfers to bank accounts, while Asian digital wallets
Digital wallets are also predicted to play a key role for users navigating Web3, the emerging decentralized internet built on distributed ledgers controlled communally by participants.
There's a lot at stake for banks. When mobile wallets first came to market, many stakeholders tried to take over the market. Banks fought toe-to-toe against retailers, wireless carriers and tech giants. Ultimately the victory went to Apple, Google and Samsung, which preload their respective "Pay" wallets on the handsets they sell.
But the rapid shift to digital payments during the COVID-19 pandemic opened a new front in this war, which is now moving away from the physical point of sale where the likes of
"Identity wallets, crypto wallets and mobile payments for EV charging, parking and tolls all represent interesting use cases that could lead to potentially different wallets than what we see today," said Zilvinas Bareisis, an analyst with Celent.
Most of these concepts aren't likely to become widely used in the U.S. for at least a few more years, because of consumers' entrenched habits and the relative utility of existing payments systems, said Sara Elinson, a partner in the financial services practice at Ernst & Young.
"The digital wallets we have here now are getting good traction for everyday payments, but it's also not science fiction to say that we're probably going to start seeing some new digital wallet capabilities in the U.S. in the next couple of years, and banks should be watching for opportunities to get involved," she said.
Interest will likely build among subsets of consumers eager to consolidate more financial activities — from identity and transit to managing crypto and non-fungible tokens (NFTs) — in a bank-grade digital wallet, Elinson predicted. But development will require collaboration, which is often a stumbling block for U.S. banks.
"The problem we've faced with U.S. payments technology development in the past will likely be a problem in developing broader capabilities for digital wallets, which is territoriality. The tendency is for every bank and network to try to retain primacy, and make sure they control the funding mechanisms and try to have their own pay button," Elinson said.
To stay relevant with next-generation currencies and digital wallets in development, banks may need to concede some turf to enable more capabilities while balancing risks and helping to shape regulations, experts say.
The rise of Web3 may present opportunities, with use cases ranging from gaming and the metaverse to decentralized finance likely to require Web3 wallets in the not-too-distant future, observers speculate.
Decentralized financial solutions and "DeFi wallets" like Zeal — along with exchanges and smart contracts — present the largest potential threat to the U.S. financial industry, but they face steep challenges, said David Grinberg, fintech director at TechMagic, a global software firm established in 2014 that has offices in London, Poland and Ukraine.
First, DeFi concepts operating in the U.S. would require anti-money-laundering and know-your-customer solutions, and so far no one has devised a DeFi solution to manage these requirements at scale, according to Grinberg.
"DeFi will also need some sort of clawback mechanism to assist victims of scams, which goes against the basic [irrevocable] mechanical notions of blockchains. If this isn't solved, these products will never get past the early adopters and technical users," he said.
There has been activity by Congress and the Office of the Comptroller of the Currency to regulate banks acting as custodians for
Another opportunity for banks may be in managing custody of crypto transactions and assets through digital wallets, he said.
Banks eyeing transactional digital wallet capabilities like those sketched by Zeal must design their roles with an eye on generating revenue and offsetting risk, McPherson said.
"There may be an opportunity to charge a small fee for real-time transfers to exchanges, from which a digital-assets wallet is funded, because that reduces the risk of a return, which in a Web3 context is problematic, due to the irreversible nature of Web3 transactions," he said.
Web3 broadly represents significant opportunities for the financial services industry to provide secure methods for managing crypto, NFTs, central bank digital currencies and smart contracts, said Serena Chan, head of innovation for design and experience at Capco Canada, which advises many banks on future technologies.
"This emerging technology and its assets are disrupting the financial services industry because of the volume of decentralized finance exchanges," she said, adding that banks increasingly will see fintechs and other startups working with Web3 technologies to develop more efficient and innovative financial services products.
With the simultaneous explosion of new ideas and opportunities around generative AI and beckoning new capabilities from digital wallets, banks can't count on consumer complacency to automatically retain their roles in the financial ecosystem, said Hugh Tallents, a senior partner in the boutique corporate consulting firm cg42.
"The U.S. is way behind the rest of the world in next-generation digital wallet development and adoption, but there's still time for banks here to look ahead and start to plan. They must think about capitalizing on the stickiness of their customer relationships and collaborate to meet consumers' needs," he said.
