Micropayment: What it is, How it Works in Fintech

What Is a Micropayment?

Micropayments are small transactions or payments usually of less than a dollar—and, in some cases, only a fraction of a cent—that are mainly made online. Micropayments are seen as a way to leverage the internet to facilitate the immediate distribution of digital rights, royalties, in-game purchases, online tipping, and even to coordinate devices connected via the internet of things (IoT).

The definition or size of a micropayment differs across payment processors and businesses: some companies recognize all transactions below a dollar as micropayments, whereas others classify micropayments as amounts below $5.00, $10.00, or sometimes $20.00.

Understanding Micropayments

The latest technology advancements have brought about more exposure and inclusion into the digital world. Fintech, technology in finance, is an emergent sector that is focused on making financial products available to all consumers at a negligible price.

These technological efforts are seeing consumers’ costs diminish to as low as a few cents. The problem with such low fees is that they may not feasibly be processable through credit card companies and their traditional transaction fee-based system. Micropayment systems have emerged to meet those needs.

The term "micropayment" was coined by technology futurist and philosopher Ted Nelson in the 1960s as a way to pay for individual copyrights on online content. Nelson envisioned micropayments in the neighborhood of one ten-thousandth of a penny. Such payments would allow users to pay for online content and allow the creation of low-cost networks as opposed to an advertising-based model. 

While the World Wide Web now works on an advertising-based model, Nelson's idea laid the foundation of the now-ubiquitous hypertext transfer. Currently, micropayments are not yet a common way of paying for internet content.

Micropayments In Practice

Micropayment platforms built for handling small transactions work in a number of ways. One way is for a seller or service provider to have an established account with a third-party micropayment provider who collects, stores, and distributes the payments made.

Through a digital wallet managed by the provider, payments are stored until they accumulate to a larger amount, at which point they are then paid out to the recipient. For easier facilitation of payments, it is necessary for consumers to also set-up an account with the same micropayment provider.

Let's look at an example. Upwork is a website that matches freelancers with companies that have temporary projects. A company may hire a video editor from Upwork to edit a few of its commercial videos for a rate of $5/hr. If the freelancer completes the project in four hours, the company makes payment to Upwork, who collects its fees and stores the remainder in a digital wallet for the freelancer.

As the freelancer gets more jobs, Upwork racks up IOUs until the wallet holds a large amount of say, $1,000. At this point, Upwork makes the payment to the freelancer’s account.

Micropayment Prepaid Systems

Another way that micropayment systems work is through the implementation of a prepaid system. A user sets up an account with a micropayment processor and pays an average or large sum of money into the account.

If the provider is also used by the e-commerce platform where the user makes small purchases, the user’s account with the provider is easily debited for the dollar amount of the purchase. In effect, the user makes payments through a micropayment processing account.

PayPal offers this type of service. A user can open an account with PayPal and deposit say, $150. Later, if this same user spends $7.99 in a digital store such as iTunes, the funds would be debited from the PayPal account and used to pay for the purchase.

Micropayments in Purchasing

A micropayment is mostly limited to the realms of digital payment. Making a $0.99 purchase of a music CD with shipping and handling cost of $25.00 may not make sense to an average consumer. But paying $0.99 for the digital content of the same music album could be a more rational transaction for the buyer as no physical delivery is necessary.

Even still, many business owners and e-commerce sites have issues finding a credit card processor as the fee for processing transactions may be more than the micropayment. Also, micropayment processors may handle micropayments differently, so companies have to choose the system that works better for them and save them the most in fees.