Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Cash held in payment apps is not insured

The US economy has expanded by 375% since 1989, while the number of checks written by Americans has plummeted by 80%. Welcome to the brave new world of electronic funds transfers, once the exclusive province of banks and credit unions but increasingly accomplished via emerging mobile utilities like Venmo, Cash App and Apple Pay.

These transfer apps provide speed and convenience. They have also revolutionized interpersonal transactions like transferring money among family members, splitting restaurant checks, and settling purchases and sales on community exchanges like Facebook Marketplace and even neighborhood yard sales. But unlike with traditional banking institutions, funds held in accounts related to these nonbank services are generally not subject to FDIC insurance and can expose users to increased risks including the potential for loss of their funds if the transfer app provider were to fail. A new analysis by the Consumer Financial Protection Board warns that customers should consider minimizing balances held on payment apps over time.

Traditional payment transfers like checks, debit cards, and ACH and wire transfers are called “open loop” transactions, in which cash is moved from the sender’s bank account into a different bank account owned by the recipient according to an established network protocol. On the other hand, most of the newer payment apps are considered “closed loop” systems, where money held on the app is moved from the sender’s account into another account on the same app held by the receiver. The cash never moves outside the app provider unless specifically directed by the customer, and in general the funds held at the company are not subject to deposit insurance provided by the FDIC.

Closed loop online transfer utilities are called “peer-to-peer” or P2P applications, and they are growing rapidly. According to Pew Research, 75% of US adults have used P2P apps, including 84% of adults aged 18 to 29. It is estimated that over $1 trillion changed hands last year over these nonbank systems, a fourfold increase since 2018. The largest players in the space include Venmo, PayPal, Google Pay, Apple Pay and Cash App, but there are dozens of smaller players, and the numbers are expanding rapidly as are the risks to consumers. A recent survey by LendingTree found that nearly one quarter of all users have sent a payment to the wrong person, including 40% of Generation Z users, presumably due to the higher frequency of use among that demographic. Additionally, 15% of users reported being scammed, including 29% of Gen Z. Unlike many bank transfers, erroneous P2P transactions are not reversible.

The conventional banking system has a long history and is highly regulated. Not so for P2P transfers. What little oversight exists is a remnant of a different time directed toward legacy transfer systems like Western Union and MoneyGram, which were never intended to hold customer funds more than a few days. P2P companies sit on billions of dollars in customer assets and generate substantial revenue from investing these balances in financial instruments including riskier assets like stocks, posing the potential for substantial losses in the event of a sharp market reversal.

While these companies must obtain state approval register with the US Treasury, they do not fall under supervision of banking regulators like the FDIC and the Federal Reserve for soundness and capital requirements. This is reminiscent of the conditions that obtained prior to the collapse of FTX and other crypto exchanges that emerged and expanded rapidly before the regulatory regime had time to catch up. The risks from P2P appear far less significant than the wild west of cryptocurrency exchanges, but consumers should still be attuned to potential pitfalls.

The customer agreements and disclosures offered by peer-to-peer transfer apps are deliberately opaque and frequently make it hard to determine how much if any of the funds on deposit are subject to deposit insurance. Many providers make it difficult or impossible to immediately transfer out cash payments received in less than 2 or 3 days or charge a transfer fee to do so. Some firms offer some FDIC coverage but require a subscription to ancillary products like branded credit or debit cards subject to additional fees or automated electronic paycheck deposits. And most of these new P2P operators do not publicly disclose how much they hold in client assets or even where their funds are held.

The risk of bankruptcy is likely small for most of the established P2P app providers, but so too was the perceived threat to depositors at Silicon Valley Bank. They were bailed out only because the bank was federally chartered and subject to FDIC oversight. No such rescue should be expected if a startup transfer app crashes and burns with a pile of of customer deposits.

Users should be aware of the terms and potential exposure they assume in using P2P transfer services in exchange for the convenience they provide. Consider transferring significant cash balances to an FDIC-insured account rather than leaving them in the app to minimize possible loss and secure a better rate of interest on surplus funds.

Peer-to-peer transfer utilities have changed the payment landscape and promise to expand further into the realm of traditional commercial banking, but with any new technology, regulation and oversight lag behind the deployment of the capability. A modicum of care and diligence can mitigate the risks while embracing the benefits.

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