What Is a Payment Method?
A payment method is the way an individual pays for goods and services.
The earliest payment methods involved barter, an exchange of goods between the two parties.
Subsequent evolutions in payment methods involved the use of cash and coins and credit cards.
Each type of payment method has advantages and disadvantages based on the situation and economic conditions.
Depending on the type of payment method, there may be additional charges associated with it.
For example, payments made using credit cards incur fees in the form of processing charges while those that use cash do not have charges.
In recent times, as technology solutions proliferate across the world, there has been a trend away from cash payments.
The Federal Reserve’s 2018 American Payment Study showed that cash payments made up 26% of all payments in the US, down from 31% in 2016.
Types of Payment Methods
Several types of payment methods are used in society based on the stage of development for a given economy.
Broadly, they can be divided into two types of payment methods: cash and electronic.
A third type of electronic payment, known as cryptocurrency payments, is slowly becoming popular and may play an important role in the future.
Cash is used to denote paper-based currency and metal coins.
It is the most widely-used form of payment method throughout the world currently.
A physical number is associated with each cash artifact, representing the value of that artifact.
There are three main advantages to cash.
The first one is that it is easy to carry over long distances, allowing the user to conduct trade over geographies.
The second advantage of cash is that it is fungible, meaning one unit of cash is always equal to another unit. The final advantage of cash is that it is anonymous.
While cash-based currency have serial numbers imprinted on them, it is difficult to trace the progression of transactions using cash money.
Cash has remained the dominant payment method for several centuries but the advent of electronic methods of payment have led to a decline in its use.
An example is Sweden, which is hurtling towards a cashless society.
According to statistics, only one percent of its gross domestic product was transacted using cash by September 2020.
An opposite case is that of Japan, which has a significantly high penetration of electronic payment options and where cryptocurrencies are considered legal tender.
According to a November 2019 survey, almost 84% of Japanese citizens use cash for transactions.
A credit card is a card with a magnetic stripe that contains data relating to the card and its owner.
It connects electronically to a bank or issuing company’s servers.
Credit cards are the most popular form of electronic cards in use today.
Credit card issuing companies pay vendors immediately and later collect from the individual for a processing fee.
A FICO score, short for Fair Isaac Corporation score, tracks an individual’s history of payments and their ability to pay.
The FICO score influences the credit card holders credit limit or the amount that the issuing company is willing to lend to the card holder.
It is also used in other other industries, such as real estate, as a mark of the individual’s credit worthiness.
Credit card payments are generally made in two formats.
The first one is by using the physical card at a Point of Sale (PoS) system, which connects to a server in the background to verify balance and identity.
The second method to use credit cards is online. In this method, physical cards are not required.
Instead, credit card details are entered on an ecommerce site, such as Amazon, and used for transactions.
The site uses these details for payments each time a purchase is made.
Since the introduction of the first credit card, other variants have been introduced.
They have no credit facility and the user cannot spend more than the amount in their account.
Prepaid cards are electronic cards that are preloaded with specific amounts and users are not allowed to spend more than that amount.
Electronic transfers can be money transfers accomplished electronically or bank transfers located in two different geographies.
In both types of transfers, an originating party sends money to an Automated Clearing House (ACH) which transfers the required amount to the destination.
In electronic bank transfers, a SWIFT routing code is used as the address of a destination bank.
Money transfers are also used as payment methods between businesses.
Purely online money transfers can be made using services like PayPal.
Services like Western Union do not operate in a purely online fashion and enable sending of money using cash and in offline mode.
The rapid proliferation of smartphones has made mobile payments a popular payment method, especially in developing countries.
Smartphone applications like Venmo in the United States and WeChat in China are popular with millennials as a preferred payment method.
To enable payments via mobile apps, the account should be linked to a bank account or a card.
The relevant amount is debited from bank accounts or cards via mobile payments.
In emerging markets, such as India, mobile payments are considered a key factor enabling socio-economic development.
This is because they enable banking and lending services to underserved areas of the population by reducing the infrastructural costs for money management and banking services.
Cryptocurrencies are the latest payment method.
They are an evolution over credit cards because they allow for transfer of money and value over electronic networks that span multiple geographies.
For example, non-fungible tokens or NFTs are a type of cryptocurrency that allow for transfer of unique collectibles, such as rare digital artifacts, between two parties.
More conventionally, cryptocurrencies like Bitcoin can be used for business transactions between geographies.
Their underlying technology, blockchain, is a global ledger that is tamper-resistant and can be used to minimize conventional transfer fees that such transactions generally incur.
While the share of cryptocurrencies in the overall payment methods pie remains fairly low, it is expected to climb in the future as the technology develops and becomes easier to use.
History of Payment Methods
The development of payment methods is intertwined with the idea of money and commerce.
The exchange of goods during commerce requires an equivalent mode of currency, one that satisfies both parties.
Payment methods progressed in tandem with the type of currency being used for trade.
Bartering was the earliest form of payment method. Two parties exchanged goods that each needed.
For example, party A might trade a bag of wheat for a gallon of milk from party B.
The transaction was conducted manually, with party A transporting a bag of wheat to party B’s home and vice versa.
But there was no way to measure the equivalency in value of a bag of wheat and a gallon of milk.
As the idea for money evolved, transactions and payment methods became more sophisticated.
Cash first became prevalent in the form of coins that were created by melting metals.
Various metals were used in the process.
For example, one of the first coins is said to have been created from a mix of electrum and gold.
Roman armies used bronze coins to pay out their soldiers.
Paper money was first developed in China and became an acceptable form of payment method in Europe only in the 16th century.
In recent times, technology’s furious pace of development has led to an explosion in the various types and formats of payment methods.
Some of them have been highlighted above.
Bartering has also remained relevant and become a popular payment method during recessions.
For example, the barter economy swelled to $3 billion during the financial crisis of 2008.
Online barter exchanges enabled trading of goods across state and national borders and modern goods, such as vacation stays, became popular instruments to negotiate for goods during cash-strapped times.
Connect with a Financial Advisor
There are many different payment methods out there, and which one you choose will depend on your individual needs. If you’re having trouble deciding between cash or credit card payments, reach out to a financial advisor in Collier County, FL for more information how to decide. You may also visit our Financial Advisor page to see all the areas we serve.
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About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.