re person-to-person (P2P) payments the next wave of change for the payments space? If my family and friends serve as any indication, the answer is "yes." Earlier this month I received my first-ever payment via PayPal, perhaps the most well known of P2P service providers and a unit of eBay Inc.

I thought I was pretty hip until I started boasting to friends; turns out most of them have been using PayPal for months, if not years. Apparently, they use PayPal instead of writing checks when divvying up the cost of a case of wine, vacation rentals, etc.

eBay, which purchased PayPal in 2002, has done a lot to boost PayPal's public image. I suspect the U.S. economy has also been a factor. Lots of people, from stay-at-home moms to out-of-work programmers, have turned to eBay and/or creating online storefronts to help make ends meet. PayPal even issues credit cards now.

PayPal (along with similar P2P schemes) is the path of least resistance into the payments system for individuals running their own businesses, especially small Web-based companies. Consider my friend Mark. On his Web site he sells herbal remedies and high-end water filtration systems. Mark has used PayPal for about two years to process online sales, but recently a customer didn't want to pay through PayPal. Now Mark's applying for a merchant card account.

Ed Bachelder, Director of Research and Analytics at Dove Consulting, said we can expect more stories like this to unfold this year, as the transaction acquiring business reaches deeper inside the pockets of American consumers. "The average purchase size needs to fall in order to support more growth," he said.

Bachelder, who worked closely with the Federal Reserve on the electronic payments portion of its latest payments study, noted that the Fed's data indicate a clear trend toward greater adoption of electronic payment options, especially among consumers. Eventually, he said, only the most ardent of corporate customers, intent on squeezing out of the system every last bit of float, will be left running checks through banks' big iron processing shops.

"Debit cards will continue to eat checks," Bachelder said. Especially offline (signature-based) debit cards, he noted, because those payments get processed across the same technology railroad tracks as bankcards.

According to the "The 2004 Federal Reserve Payments Study," while Americans are writing fewer checks (36.7 billion paid in 2003 compared to 41.9 billion in 2000), the checks are for significantly larger amounts than in the past. The average check that cleared through the banking system in 2003 was for $1070, compared to $950 in 2000.

Debit cards are the fastest growing method of payment for retail purchases, posting 23.5% annual gains between 2000 and 2003, according to the Fed's data. But consumers use debit cards for smaller dollar purchases.

In 2003, the average offline debit card payment was $42, while the average online (PIN-based) debit card payment was $38. The average ATM transaction in 2003 was $85, the Fed reported.

Some Things to Expect

In keeping with debit card trends and the move away from paper check handling, prepaid cards (a category that includes various types of products, from gift to payroll cards) are gaining a lot of momentum in the marketplace.

Automated clearing house (ACH) check conversion is another hot item; however, POS check truncation (as envisioned by proponents of Check 21) probably won't gain much traction until 2006, when most banks are expected to be image-enabled.

The fastest growing payment application running through the ACH these days is check conversion. While the final 2004 numbers are not yet available, Bill Nelson, Executive Vice President at NACHA - The Electronic Payments Association, said he expects that when everything is counted, 1.25 billion checks will have been converted to ACH payments in 2004. For 2005, he said NACHA expects twice as many checks (2.5 billion) will be converted. (In 2003, a total of 10 billion payments were cleared via the ACH.)

Gift cards received a huge boost of acceptance and recognition during the 2004 winter holiday season; look for acceptance to expand even more this year.

"There's no end in sight to the popularity of gift cards," said Tracy Mullin, President and Chief Executive Officer of the National Retail Federation (NRF).

Consumers surveyed by BIGresearch LLC on behalf of NRF last fall said that they planned to allocate 11.5% of their 2004 holiday budgets to gift cards, an average spend of $80.45 per shopper. The research firm TowerGroup predicts retailers will issue 53 billion gift cards in 2005, up from 48 billion last year. The future of another popular type of prepaid card, the payroll card, is less certain as regulators consider the application of federal consumer protection laws (such as the Fed's Regulation E) to the cards, which have proven especially popular with "unbanked" Americans.

Loyalty card programs will gain more converts this year as merchants search out opportunities to differentiate themselves from the retailing pack. Bachelder said retailers will look for loyalty programs with a new twist. Perhaps something that runs through the credit card system?

Competitive Wrangling

There you have my predictions of where I see the action in payments this year. To recap:

• P2P payments and a trend toward morphing this type of transaction into credit and debit card payments
• Debit cards, especially offline debit
• ACH check conversion
• Prepaid cards

Also look for action on the legal front. I'm not only talking about the ongoing feuds involving Visa, MasterCard, American Express and Discover, either. NACHA and ACH banks may get pulled into legal proceedings over rules that currently restrict merchants in collecting non-sufficient funds (NSF) fees via the ACH.

In the waning days of 2004 a press release came across my desk from a company called CybrCollect touting its success in a legal challenge to a North Dakota Department of Financial Institutions' (DFI) cease and desist order. It seems that when a check bounced, the state wanted CybrCollect to have obtained a written authorization from the check writer before it could collect NSF fees via the ACH. A state judge overturned the ruling.

In 2003, CybrCollect was similarly successful in challenging the Wisconsin DFI rule preventing collection agencies from collecting returned check fees electronically without written authorization.

Gary Doherty, CybrCollect's President, complained that NACHA rules were behind the state DFI actions. He said he intends to continue fighting rules that prevent his company and competitors from collecting bad check fees over the ACH. Could this mean a legal fight with NACHA? Stay tuned.

Patti Murphy is Contributing Editor of The Green Sheet and President of The Takoma Group. E-mail her at patti@greensheet.com .