Despite generating an estimated $4.5 billion in revenue last year, the legal marijuana industry has yet to solve one of its biggest issues — the lack of reliable payments, banking and other financial services.
Most banks won't knowingly accept money in any form from marijuana-related businesses (MRBs) due to the money laundering risks. Banks that once advertised their willingness to serve MRBs have changed their minds.
In response to these challenges, several alternative payment platform (APP) startups have emerged. These companies purport to help MRBs and their customers to transfer funds securely without needing to handle cash at the point of sale. In some instances, these companies also aim to help MRBs that use their systems obtain otherwise elusive bank accounts.
Although APPs have generated significant buzz in the marijuana industry, compliance and business impediments likely prevent them from being long-term solutions to the denial of banking services.
In general, APPs are "closed-loop" payment systems that come in two forms: physical stored value cards and e-wallets. They work like a stored-value, prepaid debit or merchant gift card combined with an e-wallet like PayPal or the Starbucks' mobile app (some e-wallet platforms also utilize a cryptocurrency such as Bitcoin as the medium of exchange).
Value can be added in-person (like using cash to add money to a prepaid debit card) or digitally (by directly linking to a debit card or bank account). Many platforms offer consumers additional benefits beyond just payment, such as loyalty perks or the ability to transfer funds to other users.
Additionally, certain platforms offer marijuana businesses the ability to transfer funds to pay vendors or even employees — a feature that is particularly important to many marijuana businesses that may not have bank accounts and would prefer not to make payments in cash. Presumably, the banking structure is similar to that of a typical prepaid card. The payment platform has an "omnibus" account with a custodian bank that hold funds in a series of "subaccounts" or other recordkeeping means to track amounts attributable to each user.
Many APPs tout their services as a work-around to the banking system by providing retailers and growers the opportunity to avoid using cash. However, the money laundering hurdle still looms large.
Although APPs eliminate many of the risks of a cash-based system, parties who knowingly transfer or accept the proceeds of a federally illegal activity — including most parties that are involved in the issuance, loading, or acceptance of physical or digital stored value cards or e-wallets for marijuana — are still engaging in money laundering. Additionally, the use of stored value cards or e-wallets does not eliminate the Bank Secrecy Act (BSA) compliance obligations of the providers or the custodian banks that ultimately accept the funds.
Also, the money transferred via stored value cards or e-wallets ultimately ends up in the banking system at a custodian bank. Simply because the receipt of the proceeds of a marijuana sale is indirect rather than direct, a bank is not absolved of its compliance obligations or potential money laundering liability. To the contrary, even when providers of these systems purport to help their banking partners through enhanced due diligence and monitoring of the relevant marijuana businesses, banks cannot completely "outsource" their BSA compliance or risk.
All startup APPs encounter numerous challenges. First, alternative payment platforms may have difficulty establishing a "multisided platform." An example of a multisided platform is the credit card industry, which is composed of consumers, merchants and the credit card companies (i.e., the "platform"). In order to be successful, the credit card company must convince a huge number of merchants and consumers to use its platform.
Although it may be a safe assumption that MRBs have a large incentive to utilize an APP, the same is not necessarily true for consumers. The lack of success of established e-wallets like PayPal, Google Pay and Apple Pay in a typical retail environment has been well documented. Furthermore, when it comes to marijuana purchases, anecdotal evidence suggests that consumers highly value anonymity, and therefore prefer using cash. Therefore, the assumption the consumers will adopt a marijuana-related APP en masse is questionable at best.
Beyond needing a custodian bank to accept marijuana-related funds, marijuana-related APPs also need support from a host of other actors. To name just a few, this includes money transmitters (to help consumers add value to stored-value cards), mobile phone manufacturers (to allow the app on their devices), wireless carriers, or website hosting companies. It is not clear whether these actors would proactively deny a marijuana-related APP basic services, but if they do, it would be disastrous for that APP.
Possibly the most serious business risk to marijuana-related APPs is the one about which they can do nothing — the possible liberalization of federal laws legalizing marijuana and marijuana banking. Several marijuana-related banking bills have been proposed in Congress. Also, many people believe that federal drug laws completely outlawing marijuana will eventually change and, as a result, loosen up banking limitations on the industry. In either case, there would likely be a significant drop in demand for a banking work-around from MRBs.
Although marijuana-related APPs are unlikely to be a long-term solution to marijuana businesses' current inability to obtain financial services, they may provide sufficient benefits to be useful in the short-term. Despite the compliance and business challenges, these systems are available now, mitigate some dangers of transacting completely in cash, and provide a path to banking for at least some MRBs. Absent federal legislative developments that permit banks to serve marijuana businesses without risking money laundering liability, innovators will continue to offer these and other solutions to desperate MRBs. When we'll see a long term, nationwide solution, however, rests largely in the hands of Congress.
Steven Kemmerling is the founder and chief executive of MRB Monitor, Douglas Fischer is an associate at Cadwalader, Wickersham & Taft LLP, and Jodi Avergun is a partner at Cadwalader in the White Collar Defense and Investigations Group.