Venmo, Zelle, and Square Cash: How They Work and How They Make Money

Person-to-person (P2P) payments have surged in popularity in recent years, and three leaders have emerged: PayPal's (PYPL -1.14%) Venmo, Zelle, and Square's (SQ -1.68%) cash app. In this episode of Industry Focus: Financials, host Shannon Jones and Fool.com contributor Matt Frankel discuss the three industry leaders and how their surge in popularity could translate into big profits in the future.

A full transcript follows the video.

This video was recorded on Aug. 31, 2018.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the market every day. It's Monday, Sept. 3, and I'm your host, Shannon Jones. On today's Financials show, we're talking about the wallet of the future: peer-to-peer payments, the top mobile players within the space, what they do, how they make money, and how the bigger moneymaking opportunities could still be ahead for these popular platforms. 

To tackle this subject and more, I'm joined by financials guru, certified financial planner and peer-to-peer payment late adopter, Matt Frankel. Matt, how are you? 

Matt Frankel: Very good! How are you?

Jones: I am doing well. I am on the mend recovering from a bad case of allergies. Hopefully, with rain coming through, that should all change here in the next couple of days.

Frankel: Yeah, definitely. There's been a cold going around down here, so I feel your pain. 

Jones: Yeah, absolutely. But it was not enough to keep me away from this week's Industry Focus. I'm really excited about this particular topic, peer-to-peer payments. Personally, I've used just about every major peer-to-peer mobile app you can think of. Matt, I know I joked around earlier, said you're kind of a late adopter. Before we dive in, let's talk a little bit about what this entire industry is and how they make money.

Frankel: Yeah, I definitely am a late adopter here. I used Venmo for the first time about two months ago. But now I use it all the time. I definitely see the utility. I'm a big Square Cash fan, I've used that a few times. Zelle is integrated into my bank account, the one that we're going to talk about in a minute.

Basically, these are all ways to play a trend known as the war on cash. The war on cash is the new term for the trend toward a cashless society. More people are using credit cards and debit cards than ever before. I just read a statistic that the number of people who say they primarily use cash in the United States is down to 10% from about 20% five years ago. This is a rapidly expanding trend. Debit cards and credit cards took care of a lot of the issue, but there was still a need for certain transactions to be able to be made cashless. For example, when you're out to dinner with friends and you want to split the bill, a lot of places won't split a check and let you pay on your debit card for your portion. What these are apps allow you to do is, in those cases, send money for your portion of the bill directly to your friends. Venmo, Zelle, Cash. 

This has been a really underserved part of the payments industry until very recently. That's why a lot of apps have sprung up. I know Amazon, Apple, a bunch of all the big ones have their own person-to-person payment apps. But the three big ones have definitely become Venmo, Zelle, and Square Cash. It's really picking up in America, and there's still a lot of room for growth. This is definitely a big trend and worth paying attention to.

Jones: Just to underscore that point, according to one market research company, eMarketer, they're actually estimating the total value of mobile peer-to-peer payment transactions could rise to nearly $244 billion by 2021. That's up from an estimated $156 billion in this year alone. Just to reiterate, the opportunity is huge, particularly with millennials who have been really among the first to adopt these new payment platforms. It's really no wonder why you see so many jumping on to the P2P space. It comes down to speed, it's also convenience and ease of use across many of those platforms that you mentioned. 

Matter of fact, last week, I actually did some workshopping. Here at The Motley Fool, we've got a Slack channel just dedicated to selling things that maybe we have no use for or want to get rid of. I very easily was able to pay a colleague simply by knowing what her phone number was for a particular piece of furniture. The ease, the convenience, the simplicity of the entire space is a huge opportunity, and you're really starting to see it pick up even more steam.

Now, one thing I would also mention, too, is, one of the biggest advantages, one of the biggest draws into the space, really comes down to the cost factor. For me, and using Venmo, using Zelle, using Square Cash, the cost in some cases are either completely free or I'm paying a percentage of the transaction. Matt, can you talk a little bit about how many of these platforms and these providers are finding ways to monetize these peer-to-peer payments?

Frankel: Well, most of them aren't really monetizing them yet. I know Square very well, I'm pretty sure Square's actually losing money on its Cash app, and a pretty significant amount. We'll talk about the long-term money-making opportunities a little bit later on. But the point to take away for right now is that these companies really aren't making money. As you mentioned, generally, this is free. There are some fees. For example, Square charges a 1% fee if you want your money in an expedited fashion. Venmo charges a 3% surcharge fee to use a credit card. But, other than that, there really aren't that many fees associated with these. In and of themselves, these are not giant moneymakers for these companies -- at least not yet. 

Jones: Yes, keyword is "yet." We'll get into that a little bit. First, let's actually dive into probably what many would consider the most popular among the peer-to-peer payment apps, and that would be Venmo. Venmo was acquired by PayPal back in 2013, PayPal, ticker PYPL. Matt, what can you tell us about Venmo?

Frankel: Venmo was acquired by PayPal in 2013. It allows customers to link their debit card, credit card, or bank account. They create a separate account for their Venmo payments, and they can easily move money between their account and their friends' accounts, as you mentioned, just by knowing somebody's phone numbers, or something like that. They can also link their payments to a Venmo Mastercard, by the way.

The thing with Venmo, the transfers are not instantaneous, which is the big drawback. An interesting statistic: although Venmo's often thought of as the biggest one, Square Cash actually has more downloads as of recently, and Zelle is by far the biggest in terms of payment volume, by a significant margin. Anyway, Venmo is about a quarter of PayPal's total payment volume. This is a big part of PayPal, even though, like I said, Zelle is a little bit bigger. We'll get into why in a minute. For example, during the second quarter, Venmo processed $14 billion worth of payments. That's a lot, but the more impressive statistic is the rate at which it's growing. That is 78% larger than it was a year ago. If this growth rate continues, it could eventually turn into a pretty big revenue stream for PayPal all by itself, and in other ways we're going to talk about a little bit later.

Jones: Yeah, and one interesting thing with Venmo is that it has a social media feature built into the platform, as well, which has kind of been debatable in terms of its utility. But really, with social media, basically, when I went in and actually split a gift for my mom with my sister and brother in law, I was able to put in a couple of emojis to signify that this was a gift. By default, when you make a payment through Venmo, it is public. Now, of course, you can change the privacy settings. But it's actually kind of interesting to go in and see the feed of all these different users on the platform, and all the quirky and funny things that they put into the feed. I highlight that because I think that is a really interesting play on Venmo's use of creating that stickiness factor. How do you get people coming back to these apps, not just for making or splitting the cost of a bill for dinner? How do you get people coming back to this more and more? I think that's one of the unique features of Venmo, that social media feature. Ultimately, we'll get more into how they can continue to monetize. Obviously, among the big three, this one is definitely the most well-known.

Let's dive into the next big player in the peer-to-peer payments space, and that would be Zelle. Zelle is unique in a number of ways, but more specifically in its relation to the big banks. It's even been referred to as the banks' answer to Venmo. One of the interesting things about Zelle is, initially, big financial institutions had been pretty muted in terms of interest in the mobile peer-to-peer payments space. But with a huge market opportunity, plus, also you're seeing many of the banks starting to invest heavily in technology, many of them are now getting on board. One key player behind all of that is Zelle. Matt, what can you tell us about how Zelle works and how it's playing with the major banks?

Frankel: Zelle is definitely the banks' answer to person-to-person payment apps like Venmo and Square Cash. It's the newest out of the three. In its current form, Zelle launched just last year in 2017. My guess is that the banks saw this turning into, as you mentioned, a $100 billion annual industry and wanted their piece of it. They're afraid of getting left behind. Zelle specifically is owned by a partnership between a bunch of big banks -- Bank of America, BB&T, Capital One, JPMorgan Chase, PNC Bank, U.S. Bank, and Wells Fargo are the seven that all own a piece of Zelle. So, if you notice Zelle all of a sudden integrated into your Wells Fargo account, for example, that's why.

Zelle has a few unique features to it in opposition to Venmo. First, you don't need a separate account to use it. Venmo, you essentially create a Venmo account where you loan money, like a PayPal account. With Zelle, you don't need a separate account. It uses your existing bank account to transfer to your friend or whoever you're buying something from, to transfer to their bank account. Zelle also has very fast processing times. In most cases, the transactions are processed virtually instantly.

Zelle is the banks' answer. It's the biggest of the three in terms of payment volume. It did about $75 billion in payment volume in 2017. It's doing really well so far. It's really having the intended effect of keeping a lot of person-to-person payments in these banks' ecosystem.

Jones: You mentioned that $75 billion in transactions last year. Just to note, that was actually more than twice the amount of money that customers transferred with Venmo, a huge rival. I really think it comes down to their competitive advantage, which is really their integration. When you look at the peer-to-peer payments space, oftentimes you think of millennials and mobile apps, because, as you mentioned, Matt, Zelle is built right into the existing legacy platform of these banks. It really is extremely seamless. I've used Zelle within my own banking platform. It didn't even feel like I was doing anything different as I would be from transferring money from one account to another account. It was really that easy and that seamless. I think that's a huge advantage, especially as you think about older demographics, who may be a little bit more sensitive to, first downloading an app on a phone, inputting credit card or debit card information, and then sending money to someone. I think that Zelle has really opened up the gates to a much wider demographic long-term. It's no shock there to see just how fast they're growing. 

I think there's also the advantage of the relative amount of safety when you're doing it from within your own bank. When I went to transfer from myself to my sister recently, I was really impressed at just how seamless it was. I didn't have to worry about having my credit card information in another third-party app and sending that over. Granted, it's not foolproof. There have been some cases noted in the media where people who transferred through Zelle may put in the wrong phone number or whatever, it goes to the wrong person. But there's an inherent level of safety, of comfort, that I think appeals to a much broader audience with Zelle moving forward. 

So, yeah, I could definitely see Zelle continuing to expand. Also, going back to eMarketer, the marketing research agency, they actually noted they think Zelle could become the most popular platform by 2022 as more and more institutions continue to integrate it into their systems.

Frankel: Yeah, definitely. Zelle definitely has the advantage of people not having to go to a third party to take advantage of the ability to send person to person payments. As you said, people who are not millennials, like the late adopters like me, Zelle was actually the first one I used out of all those just because it was already integrated into my bank account and I didn't have to learn anything new. I'm a borderline millennial. That's why I eventually went to the Venmo direction. 

Anyway, Zelle has that advantage. They already have a built-in customer base. That is their advantage, and why they're already the biggest in terms of payment volume, and will probably remain the largest in space, at least for the foreseeable future. 

Jones: Let's turn our attention to the last of the big three. I would consider this one of my favorites. That's Square. That's ticker symbol SQ. That with its Square Cash app. Matt, what can you tell us about Square?

Frankel: I'm with you, I love the company itself. In terms of the Square Cash app, it launched in 2013, right around the same time that Pay Pal acquired Venmo. As I mentioned, it just hit more downloads than Venmo. It's been downloaded 33.5 million times. There's about seven million active users, which is a pretty big number for such a young industry.

Square Cash has a few unique features. It's usually instant, unlike Venmo, which is a big advantage. It has bitcoin integration. Square Cash users can use the app to buy bitcoin, which is really unique. Square has taken the lead in terms of cryptocurrencies among all the peer-to-peer payment apps. It has an adjacent debit card similar to the Venmo MasterCard called the Cash Card. 

While Venmo uses a social media type feel to enhance the user experience, Square is doing some different things. One of them is called the Cash Boost rewards program, where users can get a rebate at certain retailers or restaurants for using the Square Cash app or paying with the Cash Card. That's really caught on so far. Cash Card use has tripled since just December. This is growing at an extremely rapid pace. Square has made it clear, through their actions and their words, that they are willing to invest tons of money into this in order to get it to where it needs to be. 

I mentioned that I'm pretty sure Square Cash is losing money. Their Cash Boost program, for example, they're funding completely by themselves. But if the growth justifies it, then from an investor standpoint, it's definitely a good move. Square Cash could widen its lead over Venmo, in terms of downloads. I would not be surprised at all to see that.

Jones: I agree. I could certainly see growth outpacing there. I think what's interesting too, you mentioned bitcoin. Customers now can buy and sell bitcoin directly from the Cash app. What's interesting to me about that is, even though bitcoin's price has fallen quite dramatically since topping out late last year, the app's downloads have continued to rise triple digits. When I last looked early this summer, it was up nearly 153%. I think the launch into bitcoin, very interesting, very smart. I know Jack Dorsey really believes that bitcoin will be the currency of the future and that we will be using everything, paying for everything with bitcoin. We'll have to wait and see if that ever becomes true. But, I do think, in terms of innovation and their ability to invest where it matters, will really pay off for Square overall.

Frankel: Yeah, definitely. I wouldn't go so far as to say that bitcoin is the reason that Square has surpassed Venmo now, but it definitely gives it its own customer base there. Anyone who wants to send person-to-person payments and is also interested in cryptocurrencies, that's their only choice. So, it definitely gives them a steady flow of customers that, eventually, over time -- if Jack Dorsey's right, especially -- will turn into a big revenue stream.

Jones: Yeah. Key word is "if" there, Matt.

Frankel: That's true.

Jones: Even with bitcoin, certainly, it's by no means profitable for Square at the moment. Turning corners here, Matt, we've talked about the big three players, what they do, how they make money. But, in your eyes, you actually don't see peer-to-peer payments as being the big moneymaking opportunity. You think there are some other ways that they can branch out and pull in the big bucks. Let's talk a little bit about that. Where do you see this field evolving? And how do you see these players becoming more profitable?

Frankel: Well, it depends which company we're talking about. Zelle, for example, I see as more of a defensive app. Its main function is to prevent loss of business for the banks. If Venmo or Square Cash does every function they would need in terms of their banking, then Zelle can stop the bleeding of business. 

For Venmo, right now, what the app is doing is bringing more people into the PayPal ecosystem. It's creating more potential customers that could use PayPal's other platform, that could be used to cross-sell other products in the future. Same with Square. Square's bringing in seven million active customers. For comparison, their core payment hardware business only has about two million active users. This is a big group of people being brought into Square's ecosystem that could be used to cross-sell other products. Square, for example, is ramping up their small business lending program, which could eventually turn into a personal lending program. Then, they already have seven million built-in customers. I mean, that's very theoretical at this point. 

The other thing is the cryptocurrencies. Right now, they're not making much money. I want to say their profit on bitcoin in the last quarter was about $30,000, which is nothing. But over time, if bitcoin becomes one of the world's leading currencies, as Jack Dorsey thinks, that could definitely be a big revenue opportunity. 

With Venmo and Square, it's not about making money in the short-term. It's about bringing as many people as possible into the company's ecosystem that could be eventually leveraged into revenue streams. With Zelle, as I mentioned, it's more of a defensive play. There's definitely a lot of long-term revenue opportunities here. 

Jones: I totally agree. I think the long-term growth opportunities definitely lie with Venmo and with Square. In late July, PayPal's COO mentioned that 17% of Venmo users have actually already engaged in some sort of monetized experience so far this year. Really, that comes down to bringing in merchants into their ecosystem, like Uber, Uber Eats, Grubhub, Seamless, Eat24, even Williams and Sonoma. They're basically adding dedicated Venmo buttons to their site in their apps. He even noted that there's demand for it, not just on the merchant side, but even for the customer side, as well. This is allowing PayPal and Venmo to really start collecting transaction processing fees directly from the merchants. That's definitely an opportunity. As you mentioned, it's continuing to bring more and more people into their ecosystem. 

With Square, you touched on it already, I think the huge opportunity is moving Square Capital from that business-focused lending to now more consumer-driven lending. Really, I think the key for Square is going to be in its data. As they continue to build out their ecosystem, and with this omni channel presence that they're building, I've been so impressed with how they've been expanding vertically in particular. But, I think what you have with that is, as you bring more and more people in, not only are you collecting data on their spending habits, not only can you start making personalized marketing recommendations, but you're also making better, more informed lending decisions. I think that's going to be a huge competitive advantage for Square in the long-term. 

Frankel: Definitely. Like I said, it's all very theoretical at this point, what could be the big money drivers. But, I mean, business lending, even if they get a small percentage of those seven million users to take advantage of personal lending services... Right now, I think Square Capital has, only about 3% of Square's merchants are taking advantage of it, and it's become a big revenue source for the company. So, like I said, even a small percentage of that seven million could be a big deal.

Jones: Absolutely. Definitely an area to keep an eye on. I'm really excited about this space. Hope our listeners are, as well. That's it for this week's Financials show. Thanks so much for tuning in! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Shannon Jones. Thanks for listening and Fool on!