Long before “Coronavirus” became a part of daily lexicon, Americans had been steadily shunning cash for electronic payments. According to a 2019 San Francisco Federal Reserve Bank study, consumers used debit cards more often than cash for the first time in 2018. A second Federal Reserve study found that almost all forms of electronic payment have been on a steady, rapid increase for the last 18 years.
But for the cannabis industry, cash remains the dominant payment method, as dispensary owners move hundreds of thousands of dollars of cash monthly, invest in cash counting machines, armored car services to move their cash, and sometimes revert to safe deposit boxes when banks decline to take their cash deposits at all.
The advantages of electronic payments are obvious: They provide security, because you don’t have to carry it around. You get immediate transparency, and don’t need to count it. And they are highly portable, since you don’t have to worry about obtaining security for large amounts.
“When you wade into the waters of the cannabis business you can find yourself flush very quickly with deposits, because the business is very expensive,” says Bob Craig, CEO of payments company PayQwick. “At the higher end for cultivation farms, because it is such an expensive product, you might be [processing] as much as $10 million a month. You’re going to be depositing a huge amount of money.”
In a series of interviews with bankers, payment company executives, attorneys and Illinois leaf-touching businesses, most of whom wanted to remain anonymous or only speak off the record because of the sensitivity of their work, Grown In found the payments business for cannabis to be still largely cash-based. While there are some electronic payments available now, electronic payment solutions are still nascent, and likely to be that way for some time.
As Grown In reported last week, a very few banks in Illinois – and nationwide – have been willing to bank cannabis businesses because cannabis remains from a federal perspective an illegal business. Although the U.S. Treasury and Federal Reserve Bank have provided a somewhat neutral perspective on cannabis, they still require banks to treat even the most upstanding cannabis businesses like potential money laundering operations. To comply with federal regulatory guidelines, U.S. banks banking cannabis need to file weekly “suspicious activity” reports on every cannabis business’ activities.
That opening for cannabis banking has been held to a crack, however, as the Trump Administration’s Department of Justice rescinded a 2013 memo from the Obama Administration that directed U.S. Attorneys to focus on non-cannabis-related matters. Today, each of the 94 local U.S. Attorneys can set their own policy on whether or not they will prosecute and seize cannabis businesses.
So far, U.S. Attorneys in states where cannabis sales are legal have chosen to overlook cannabis, but from a banking perspective – especially for banks that operate in multiple states – even a slight risk of criminal prosecution is too much risk.
“There’s always a risk that Fed could come and shut down the bank, remove FDIC deposits, or put the bank under review because you’re money laundering for drug dealers,” one cannabis banking expert told Grown In.
The Payment Rails
In 2018, the most recent year data has been collected, the San Francisco Federal Reserve Bank reports 54% of all payments were managed through a debit, credit or prepaid card, which generally requires using the Visa, MasterCard, American Express, or Discover networks in the United States. Other payment systems include prepaid gift cards, like the ones found in the Target checkout aisle, or ACH payment systems that use an ATM-like system to transfer funds.
Those networks are also known as “payment rails”, referring to a complex stack of technology and interconnections maintained by the payment companies. For instance, when a payment is initiated at a typical retail location, the following process is initiated:
1. The selling business starts a payment request by running a card through a terminal provided by a merchant services company (or alternately through an online payment “gateway”), which connects the selling business to the payment network, for instance Visa, through the terminal, and connects the selling business’ bank account to the network through a merchant account.
2. The merchant services company then passes the payment request to the network, which then queries the issuing bank to see if there’s enough money.
3. The issuing bank is the bank name on your credit or debit card, like your Citibank Visa, Commerce Bank MasterCard, or just American Express, which is both a payment network and an issuing bank. The issuing bank then replies whether there is enough money available, or even if the card is valid, and approves or declines the transaction.
4. Assuming the transaction is valid, the network notifies the merchant terminal, which allows the selling business to either complete or terminate the transaction.
5. Assuming the transaction is sent to completion, the network then requests funds from the issuing bank and then settles the transaction with the merchant account, meanwhile distributing transaction payments to the merchant services company, the merchant account bank, the issuing bank, and network along the way, everyone taking their percentage. Most network payments are completed within 1-2 days – all during which the network holds the funds as a floating balance.
While the network rails are far from efficient – payments have to make a few days stop with a middleman like Visa or MasterCard, rather than simply transferring from one bank to another – the process has become so widespread and so lodged in consumer consciousness that it’s the most convenient way for businesses to get paid by retail consumers.
And then there’s the cannabis business.
No Love From Visa and MasterCard
Visa, Mastercard, American Express, and Discover have all established policies restricting the use of their payment rails until cannabis has been federally legalized in the United States. In contrast, in countries where cannabis is legal, like Canada, their payment systems can be used.
While some merchant services companies have issued terminals to dispensaries, those that do so are violating payment network terms of service.
“If you use a credit card, the retailer has a merchant code for the [type of] business they operate, but there isn’t one for a dispensary. That’s by design. The only way to [process payments is] by lying to Visa or Mastercard,” says Zane Gilmer, a cannabis banking attorney from Stinson.
Some dispensaries, desperate to process cards, create shell companies to process their payments, for instance categorizing themselves as a grocery store with their merchant processor. As soon as payment networks discover those violations, they immediately shut down those merchant terminals, says Gilmer, freezing any payments in process, jeopardizing the merchants’ ability to get paid for product that already left the store.
Payments Are Like Water
“As we say in the payments business: Payments are like water, they find a way,” says PayQwick’s Craig. “Many entrepreneurs are trying to figure out a way merchants can run a card at retail. Most of them have created a thing of stored value, such as a gift card, an account, cryptocurrency, or another tokenized system. There are many flavors, like an ice cream store. In many cases Visa-MasterCard have said, ‘We don’t like this one, shut it down please.’”
And that has resulted in a multitude of unique solutions for dispensaries to take payments. The most obvious solution is by just hosting a bank’s ATM on the dispensary premises. Customers can make cash withdrawals for the amount they need, and then pay cash at the point of sale. But with ATMs, customers often have to pay fees of 3% or more to withdraw the cash they need.
“We’ve got two ATMs with a 50-cent fee,” says Dispensary 33 owner Zach Zises. “Now that we’re pre-order only it’s no big deal. [But] I can imagine you can get more impulse buying if someone has a credit card, we’re so used to operating this way.”
Some dispensaries provide merchant terminals that by-pass network payment rails by using ACH-transfers, essentially the same process as ATM machines. But like with ATMs, the customer has to pay a percentage on the ACH transaction, sometimes as much as 9%, and then the customer’s bank levies a fee because it is a non-bank ATM.
Some dispensaries offer private label gift cards with preloaded values, like the kind offered in the Target checkout aisle, but these have a limited value and are non-transferable – if you lose it, you’ve lost your money.
PayQwick and competitor POSaBIT provide a similar kind of service, except instead of placing the funds on a physical card, PayQwick operates an app that transfers funds to dispensaries that participate in their system. POSaBIT operates terminal-like systems that process physical non-bank cards for dispensaries participating in their system. Both are “closed-loop” systems, requiring customers to sign up and transfer funds to their system, unlike network payments, which transfer funds from issuing banks on an as-needed basis.
“Even if you get a FinTech solution to get around Visa or MasterCard’s networks, you still need a bank to monitor the transactions,” says attorney Gilmer, “just as if they would if the money would be coming in from the dispensary in regular transactions. Fintech can solve this, but you still need a bank that will oversee the transactions.”