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FedNow’s legal terms contain a game changer for digital wallets and payment apps

A few lines buried in the legal terms for the FedNow service, which is now live, create an important opportunity for digital wallet and payment app providers. While the new FedNow legal regime creates significant business opportunities for all players in this space, emerging nonbank payment providers may have the most to gain from this change.

Early-stage startup founders and investors in particular should take note. These provisions allow nonbank providers access to FedNow under a remarkably open approach, with only a few requirements imposed on their relationships with customers and a back-end bank. The effect is to allow these nonbank providers to increase their reach beyond their own user base (as they are limited today) and potentially also enable payment flows across other apps and wallets and payment networks.

Rather than orient their business around customer acquisition and user base growth, early-stage startups would be able to play to their strengths and center on building innovative software solutions — ones that identify new opportunities and deliver a better and safer customer experience for instant payments.

Payments on the cusp of change

Rarely do we see wholly new digital wallets or payment apps launched by nonbank startups today. Instead, the biggest payment app providers tend to grow bigger: Their app becomes more useful as the number of customers using it grows. That is because the payments these nonbank providers are able to process within their own system are limited to only transfers between their customers.

The potential reach for nonbank payments providers who leverage this provision in the FedNow legal terms could be significant.

As a result, the larger the user base of one particular wallet or app, the more likely it is that a payor can use it to make a payment to a payee, increasing that system’s functionality and value. Because of these network effects, the barriers to entry for new nonbank payment systems are high.

But what if there were some way for a startup to launch a wallet or app that allows its users to also send money directly to a bank account or to a wallet with a totally different nonbank provider — cheaply and within seconds?

This possibility would mean that the usefulness of that payment solution would no longer depend on the size of the nonbank provider’s own customer base. Instead, even nascent payment solutions could reach nonusers who are customers of banks and possibly of other nonbank providers.

A new payments app could launch with readily available reach to a vast network of payors and payees. Both startup payments providers and today’s dominant providers could broaden their reach.

This possibility is real with the FedNow Service and, in particular, its legal terms for nonbank providers.

The FedNow legal terms

The FedNow Service is a new instant payment infrastructure developed by the Federal Reserve. The service went live on July 20, 2023, and enables consumers and businesses to instantly send and receive money through their banks, around the clock and every day of the year, with funds to be available to the recipient immediately.

Importantly, the Federal Reserve designed the FedNow Service to enable fintech companies and other nonbank providers to integrate instant payments into their more innovative and customer-centric services. This goal is evident in how the Federal Reserve’s approach to these nonbank providers differs from that of The Clearing House (TCH), operator of RTP, the private-sector instant payment service.

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