It was almost impossible to miss Apple’s product announcements yesterday. The usual new iPhones but also an Apple Watch that itself offers fascinating innovations in the user interface; but that is something that I’ll look at another day.

From an economics perspective, however, the biggest news was Apple Pay and near as I can tell the commentary has missed the importance of this. If particular, the commentary has missed what problem Apple Pay solves. And the answer is: the identification challenge.

The identification challenge (and economists will be familiar with this) is working out if X ‘caused’ Y. Of central importance in the economy is working out if a particular person (X) caused a purchase (Y). This ensures, in particular, that the person who acquires a good or service actually pays the merchant selling it. Cash does that job but cash has some insecurity built into it as it can be easily lost or stolen. Credit cards do this in a different manner: by providing a means of identifying the particular person and assuming that identification is correct; in other words, causal in the manner everyone is relying upon. It does this (a) by having a physical card andusing a signature, pin or physical swipe of that card or (b) having the card number, a security code and other identifying information. But in each of these there is a possibility that another person may substitute themselves in as the intended particular person (i.e., identity theft or fraud) in which case the inference is wrong. This has been handled traditionally by the card issuer being responsible for those mistakes or security issues. Consequently, it was up to them to build some of the cost of that into the charges (i.e., the interchange fee) it charges merchants who accept cards. There are other costs in payment systems to be sure but a failure to perfectly solve the identification challenge is a big one and it impacts on everyone who takes part in the system.

Apple Pay as we saw it demonstrated makes transacting with a credit card dead easy. Take out your phone, put you thumb on the Touch ID, touch the phone to the card pad and you are done. Apple Pay also has an API for third party apps which means you can use Touch ID to pay instantly from an app. It is arguable that ‘ease of use’ was one of the reasons why Google’s attempted mobile payment solution using NFC did not take off; put simply, by the time you take out the phone, open the app and put in the pin, you may have well just taken out a credit card. So Apple’s solution looks like it will be an easier sell and may drive some adoption. But don’t hold you breath. It will take some time before iPhones capable of this are in the hands of a critical mass of consumers.

This is why I think the resolution for the identification challenge is more significant. Last year, with the iPhone 5s, Apple finally got fingerprint recognition right. Last week I actually had to use a iPhone 5c for a few days without Touch ID and I couldn’t believe how much I had learned to rely on it. It really does work and you really do use it and it really is less hassle than a pin or even swiping to unlock the phone. But the security issues were not paramount but a fortunate side product.

Now they are paramount and what is more Touch ID solves the identification problem. It is really hard for criminals to spoof it or steal your identity using it. They would literally have to hold a gun to your head or take a hostage and, frankly, at that point, they are better off just robbing merchants directly.

With that in mind think about what Apple can offer payment networks (banks, AmEx, Visa and MasterCard). Those fees they have to build in to account for fraud — and apparently much of that occurs when merchants or store clerks get to see your card and other information — can be eliminated when Apple Pay is used. Indeed, if Apple has indeed solved the identification problem, Apple can offer to assume the fraud risk on Apple Pay accounts. That means that Apple can pocket on each transaction some portion of the previous cost assigned to fraud. We are unlikely to get a sense of that until it shows up on Apple’s balance sheet in a few years time, but if I had to guess, this is why Apple was able to get the major payments systems on board. It costs them nothing, allows them to reduce costs, and also assists them in driving merchant adoption of technologies that will reduce fraud both for physical and online payments. This is the big news here and Google and others are far behind on this one.

I expect we will see Touch ID on iPads and all Macs soon and that will have a major impact on payments online. Indeed, I have to wonder whether Amazon may jump right into it.

Which brings me back to the Watch. (By the way, for we bloggers writing about this, Apple Watch is a terrible name compared to iWatch or, for that matter, iPay. I wonder, in fact, if the Apple assigned names will stick). The Watch will allow the consumer to pay for things by tapping the card terminal with a double tap of some button on the Watch. That seems easy but there is a missing element in the picture: identification. Even if your phone is proximate, to get proper identification, you would need to reach into your pocket or bag and touch the Touch ID button. You may as well just use the phone. So that doesn’t sound like how it will work.

So how will Apple solve the identification issue with a Watch given that they didn’t put Touch ID on the Watch itself? My guess is that it will use heartbeat identification. The iWatch has built into it a heart monitor. That has currently been sold as a health feature (or a strange alternative to ‘Yo’) but, in fact, you can identify a person by their heart rate. A prominent graduate of the University of Toronto’s Creative Destruction Lab is Bionym. They have patented technology that allows such identification and have built it into a soon to be released band called Nymi. Here is a video demonstrating it:

Bionym has a solution to the identification problem. The technology itself can surely be put into the iWatch. I have no special knowledge on this — I imagine that the venture would be subject to lock-hard secrecy — but one can imagine the patent that does this is a licensing opportunity for Apple here. What is more, if the Nymi is released as intended, then it is the solution Google and others can use too. In fact, it has more potential in this regard than Touch ID.

I guess we will find out next year. But the point here is that yesterday Apple launched the most significant innovation in payments since the credit card itself. Few people have noticed and that includes the market that took Apple stock on its traditional, post-announcement, plunge.

18 Responses to Apple’s new Identification Revolution

  1. Jim Kay says:

    Well now, Joshua, I don’t understand how you missed the history. More than ten years ago, HP put a fingerprint reader on one of its laptops (I had one) and then dropped the technology because it was too easy to fool it. In my personal experience, it was terrible.

    When Apple first introduced its fingerprint reader, it took about two days for a group of hardware hackers to break it. All they really needed was some samples of the owners’ fingerprints. So if someone steals your phone, well, it’s covered with sample fingerprints. There are a lot of other problems with fingerprint readers and Apple has most definitely NOT solved them.

    Granted, the hackers agreed it wasn’t easy and most people won’t have the ability to do that at home, but the stakes are very high and the criminals are likely supported by governments (or are the governments.)

    You are most definitely celebrating much too soon and giving Apple considerably more credit than they deserve.

  2. Tony Mellor says:

    Interesting, but as Jim Kay (above) implies this isn’t really ‘all that’. Apple has discovered NFC (finally) and put it together with Touch ID to leverage the vast goldmine of iTunes associated credit/debit cards. This was, quite frankly, pretty much expected. It will undoubtedly makes tons of cash from this, but good-enough authentication systems on low cost handsets will come, and this is a market that Apple still doesn’t want (or need) to compete in.

    Any player could (and probably will) develop, implement and license other biometric mechanisms or technologies for mobile payment. The barriers to entry are not really that high – it’s the critical mass of high spend cards that makes this good business for Apple.

    M-Pesa is big in Africa – linking into carrier payments systems, but this hasn’t gained much traction in Europe where the need for cashless payment is less clear, and chip & pin is now fairly ubiquitous. The opportunity to finally drive the move away from mag-stripe in the US is probably the biggest reason for the card providers getting on board.

    The bigger take-away from yesterday’s event for me was the lack of strategic innovation in product. This feels eerily like Apple going down exactly the same route as Microsoft did after the baton was passed from visionary founder to a (‘merely’) competent operations director – no disrespect intended to either Steve Ballmer or Tim Cook. Two bigger phones, an NFC chip and a smart-watch with no compelling reason to buy. Would Steve Jobs have gone down this road? Maybe, maybe not. Don’t get me wrong, these things will still sell by the truck-load and Apple’s bottom line is in no danger for the foreseeable. But game changing innovation? Not seen that since the iPad, with it’s full ramifications still only just working through the PC market. And the biggest category shift was arguably accidental i.e. the ‘App’ revolution.

  3. Outstanding post! Biometrics is finally coming of age after decades of anticipation and false starts. Was thinking vascular identification was Apple’s plan for biometrics (on top of fingerprints) until I read this. Fascinating to learn about Bionym and heartbeat id.

  4. Amir Sa says:

    The reality though is that buyers put much lower weight on potential technical holes of ‘fingerprint technology’ than the simplicity it brings to, let’s say, paying at the point of sale (unless too many cases of significant theft overwhelm the media, which I believe is highly improbable given that Apple is behind it). What I, as a buyer not economist or analyst, value is how a new, yet simple technology can reduce the opportunity cost of doing a task for me.

    I agree with Joshua’s point that Apple Pay’s significance is well missed by the media. Why? Hard to understand for me but if you watch the short keynote video posted by Apple, a considerable portion of video is dedicated to introducing and magnifying this breakthrough leap — which well demonstrates how confidently Apple relies on this feature for its marketing purposes.

    • Jim Kay says:

      “(unless too many cases of significant theft overwhelm the media, which I believe is highly improbable given that Apple is behind it).”

      The previous attempt at fingerprint identification by HP was overwhelmed. It took hackers two days to defeat Apple’s fingerprint reader back when it was first released.

      Is there some basis for your belief or do you just have apples in your eyes?

      • Amir Sa says:

        I have apples in my eyes 🙂

      • Amir Sa says:

        Now, apart from the joke, I believe you are missing the big picture. Think about what makes MC, Visa and other major credit card providers partner with Apple for this feature. Reduced costs! Correct! How would that happen? By reducing the number of Credit Card and identity thefts and calls to banks for unrecognized charges on customers’ statements. So if we are to assume that MasterCard, for example, is not totally irrational in making such an incredible partnership decision, it is fair to say Apple Pay is making world a better place for CreditCard holders, so does for MasterCard’s board of directors. This reasoning though is finding the cause from the effect. But we can go the other way around: What kind of hacking are you thinking about that worries you too much?
        1-your phone’s stolen? Call your carrier and lock the phone — alternatively log in to your iCloud or iPhone finder and erase/lock your phone. It is certainly much faster than calling your bank to report a stolen CC, have a new card replaced and mailed to you!
        2-Worried about your finger print being copied from the reader!? Well I should say your fingerprint is on almost anything around you — so if you are really worried about your fingerprint being copied then don’t even think about touching anything around you, seriously.

        My point is that although hacking is an inevitable threat to Apple’s fingerprint technology, it is so to any digital technology we use everyday, including but not limited to Banks mobile apps, and Clinics’ patient record databases. It’s just that the trade off between the benefits and costs is what makes the difference. You might as well think it’s way easier to copy the new PayPass chips and tap ones copied chip on credit card machines steal cash — simple hacking! Did that make PayPass fail? I don’t think so.

  5. Jim Kay says:

    “1-your phone’s stolen? Call your carrier and lock the phone…” By now you should know that doesn’t work. In fact, Apple removed the locking feature from its phones (that creates more phone sales and more accounts for the carrier. If they announced they are putting that back, I missed it.)

    I’m not worried about my fingerprint being copied from just anyplace, I’m worried about my phone being stolen and my fingerprints on the phone being used to compromise the Apple wallet. THIS has been demonstrated! It’s not just an idle worry.

    This is not the first try at a micropayment wallet. The ‘big picture’ is that nothing has gained traction yet and there is no obvious reason why Apple’s attempt is any better than the rest.

    (I have a PayPass on my one card that Costco accepts and I use it, but it does essentially nothing to make my life easier. Depending on how much I spend, sometimes I have to sign and sometimes I don’t. Ho Hum! First I have to show the cashier that I want to use PayPass, then I have to wait for the cashier to push some buttons that activate the PayPass reader. Then I have to wave my card at the reader. Then I have to wait and see if the cashier is going to hand me a ticket to sign. Finally, I get my receipts. This is worse than handing my card to the cashier and I don’t worry about it being copied because it never leaves my sight. I do it all for some perverse form of geek fun.)

    And yes, I do have rotten apples in my eyes 🙂

  6. Aidan says:

    Chip in a card is easier and has no battery life concerns. Stolen physical card is a much lower probability. Vendors and financial institutions only get real benefit from reduced fraud if widely adopted. Apple doesn’t have that much user share with their new phones. Not a good solution.

  7. ben s says:

    Three problems:

    1. Once they’ve stolen your fingerprint, thieves have your identification mechanism forever. If they steal your credit card, you just order another. Can’t order new fingerprints!!!

    2. Its easier to call and report a stolen credit card – if they steal your credit card but not your phone, you still have a cellphone to make that call on. If they steal your phone, you need to find another before you can call to declare it stolen.

    3. Dead batteries.

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