Could Square’s patent help it steal banks' role in payments?

Alipay and Ripple have landed haymakers against the financial services establishment by making currency exchange nearly invisible. Square hopes to accelerate this process with a nod from the U.S. government.

Square’s new U.S. patent covers a system that allows real-time transfers between parties using two different “assets.” Square's merchants have shown early interest in cryptocurrency payments, and if merchants accept this new concept, it could exist along with other Square services to support numerous use cases that involve cryptocurrencies, cross-border payments, e-commerce, small businesses, micro-merchants and broader financial services.

In Square’s vision, the payer can use any currency, while the recipient gets paid in any currency, with a network managing the exchange. The payment request can come in a traditional currency, while the user can satisfy that request with a cryptocurrency or another traditional currency. By using one or more data structures maintained by the payment service (i.e., Square), the transaction can be converted to the payee's desired currency in real-time. A “privacy coin” would also help execute the transaction while maintaining privacy of the parties.

That’s designed to address several problems that have kept cryptocurrencies from being used for general retail payments. The volatility of bitcoin scares most merchants, who are concerned about a processing gap that could result in their payment being of less value. Bitcoin transactions are hundreds of times slower than than card payments, so Square’s real-time processing would address that argument by bringing crypto-based currency exchanges faster and closer to the point of sale than a traditional currency exchange.

“The elephant in the room with crypto is the time it takes to do the exchange,” said Richard Crone, a payments consultant, adding Square's system still maintains an intermediate step between buyer and seller. “Square is claiming it can do this in real-time, and that’s what would ignite this network.”

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Another argument against cryptocurrency payments involves the actual use case. If people are accustomed to paying with dollars or euros or payment cards at a store, why would they switch to another currency?

The success of Alipay and Ripple suggests there is a growing market to process cross-currency transactions for low-value payments for shopping. Alipay, for example, has built a large network outside of its native China over the past few years by allowing Chinese travelers to pay in their own currency directly at merchants, thus avoiding longer currency exchanges.

That strategy has been bolstered by Ant’s $700 million WorldFirst acquisition to build bulk in Europe and a series of deals with merchants to gain a network in North America. Alipay has done so well in North America through this model that it’s at least temporarily punted on building a payment network of its own in the U.S.

To gain merchant support for its patented currency-to-crypto-to-currency rail, Square is armed with an existing feature that allows bitcoin trading in its Cash app.

Square Cash has become a centerpiece of Square’s effort to diversify its product line to make itself more attractive to both consumers and merchants. Square Cash’s volume has grown quickly, and Square has positioned the platform as a way for small business owners to make payments to vendors or employees, in addition to Cash’s original role as a Venmo-style P2P transfer app. Square more recently added stock trading to Cash.

Merchants have shown a willingness to accept bitcoin in surveys, and Square started letting merchants accept bitcoin about six years ago. Square CEO Jack Dorsey has said cryptocurrency will be the internet's "native currency," and Square has dedicated a team to cryptocurrency technology development — though Dorsey, who is also CEO of Twitter, has said he has no intention of creating his own currency. That strategy could help Square avoid some of the controversy that has hurt Facebook's Libra, a crypto project with many of the same goals as those outlined in Square's patent.

Square can also compete in Ripple's market by using its patented system to support cross-border transactions for online marketplaces. Ripple has built an international network by speeding international payments through its distributed ledger, removing third parties such as correspondent banks, and has been successful enough to gain bank support and partnerships with MoneyGram.

Square would not comment on its patent for this story. The patent application lists myriad use cases beyond retail payments, cryptocurrency, and traditional currency exchange — such as securities, derivatives and loans. Square has also applied for banking licenses more than once over the past few years. “What Square is describing in its patent is what the [card networks] do," Crone said.

As with any new payment type, the trick will still be convincing merchants to adopt it.

“For merchants, can they increase sales by adding another tender type?” said Crone. “Merchants did find they could boost sales by adding PayPal, when PayPal found it could get a sales lift by adding a social payment feature like Venmo.”