Micropayments and Cognitive Costs

There have been many micropayment systems. Yet none of them have managed to stick around. What could explain the failure of the market to materialize?

Thinking Man

The main transaction costs are in the mind, not in the transaction system.

Most people cite transaction costs as the culprit. Not the technological transaction costs, that is, the annoying fees exacted by the banking sector that mostly stopped innovating in the payments space two centuries ago and started coming up with new ways of tacking on fees to transactions. The relevant transaction costs that pose a real problem are all in the user's head: Will this item live up to my expectations? What's my budget? Will I run out of my cash supply and be unable to carry out a transaction that I really care about later?

Cognitive costs of managing money, no matter how small, create friction and may even trump the benefits to be had from the microtransactions themselves.

I just came across Nick Szabo's interesting paper, from about a decade ago, titled "Micropayments and Mental Transaction Costs." His analysis is spot on:

A lesson for micropayment efforts is that mental costs usually exceed, and often dwarf, the computational costs. ...

We have seen how customer mental transaction costs can derive from at least three sources: uncertain cash flows, incomplete and costly observation of product attributes, and incomplete and costly decision making. These costs will increasingly dominate the technological costs of payment systems, setting a limit on the granularity of bundling and pricing. Prices don't come for free.

Indeed, the mental transaction costs, aka cognitive costs, take a toll, even, or especially, for a 100 bit ($.003) transaction. This is why replacing ads with micropayments is a non-starter: far fewer people tip. It's not because they are miserly, it's because the act of tipping takes not only an extra physical step, but also exacts a mental toll. In contrast, ads are hassle free for the user. Micropayment systems have to address these mental transaction costs if they are going to have any longevity.

Speaking of micropayment systems, the following paper is quite interesting:

Ronald L. Rivest and Adi Shamir. PayWord and MicroMint: Two simple micropayment schemes In Proceedings of CryptoBytes, pages 69-87, 1996.

I mention it for two reasons:

  1. to point out that the technique it uses to achieve scarcity is very cool, is reminiscent of Bitcoin, and predates Hashcash, the system that many practitioners believe to be the earliest entry in this space.
  2. to drive home the point that microtransaction systems are more than two decades old by now. The introduction section of this paper provides a good sense of just how many micropayment systems have been invented, deployed and failed.

A sustainable success story in the micropayment space will require innovation in the user experience to bring down these cognitive costs.

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