This Could Be Apple’s Biggest Innovation Since the iPhone

This spring, Apple CEO Tim Cook offered a vision of the company’s future – to anyone reading between the lines. “We have almost 800 million iTunes accounts and the majority of those have credit cards behind them,” Cook said in a quarterly conference call with analysts. “We already have people using Touch ID [Apple’s fingerprint reader] to buy things across our store, so it’s an area of interest to us.”

That “it” refers to virtual wallets – smartphone apps meant to replace the need for credit cards and cash. Virtual wallets have been a drop-dead obvious idea since at least 2011, when Google launched its much heralded Google Wallet for Android, i.e. “tomorrow’s billfold.” Three years – and nearly half a billion dollars in investment later – the Google Wallet has been largely ignored by consumers. Meanwhile, competitors like Square and its Square Wallet app have also officially thrown in the towel.

Getting people to ditch old-fashioned cash and credit cards, it turns out, is harder that it seems. But as Apple gears up for what seems a certain foray into the virtual wallet space, consumers have good reason to believe that the days of carrying around bulging leather billfolds may – finally – be numbered.

A wallet wasteland

Among the biggest challenges facing virtual wallets: finding a use case. “[At] the end of the day, point-of-sale payments aren’t really broken,” writes Gigaom’s Kevin Fitchard. “Swiping a plastic card works just as well as it always has.” For most consumers, in other words, paying via credit card remains a fairly frictionless transaction. Virtual wallets do afford certain advantages – seamless record keeping, for starters – but there hasn’t been a pressing need for adoption.

Add to this the hurdles – both real and perceived – of switching to a mobile wallet. The tap-and-go technology behind mobile wallets generally relies on near field communication, or NFC. Concerns continue to linger about whether hackers can exploit NFC transmissions – which can have a range of up to a meter or more – to eavesdrop on transactions.

Meanwhile, Apple’s existing phones aren’t equipped with NFC chips at all, leaving hundreds of millions of iPhone users – an absolutely critical virtual wallet demographic – out of luck. At the same time, retailers have been reluctant to embrace NFC terminals, which often require costly new hardware. Instead, they’ve opted for simpler software-centric solutions, like apps that transform smartphones or tablets (equipped with tiny card readers) into a credit card terminal at minimal cost.

But the biggest obstacle for Google Wallet and its virtual brethren has been phone carriers themselves. Virtual wallets generally store users’ credit card information locally, on a special chip within phones (home of the so-called “secure element”). And individual phone carriers control access to this chip.

Rather than play along with Google Wallet, many carriers have blocked access and started competing offerings themselves (like Isis, the virtual wallet from AT&T, T-Mobile and Verizon). The result: fragmentation of the nascent wallet market and huge headaches for Google. “With Google Wallet, we had one point of failure,” explained Jonathan Wall, the project’s founding engineer, “the carriers [used] the necessity of hardware to really block the product.”

A virtual tipping point

But hardware may not be an issue much longer. The latest Android phones (as well as Blackberry devices) have found a way to store credit card information securely in the cloud, rather than on a chip inside phones. Known as host card emulation or HCE, this technology enables virtual wallets to make an end-run around carriers, cutting them out of the equation entirely. “With HCE, Google has opened the floodgates for NFC payments and created a level playing field for all mobile wallet providers,” explains mobile commerce consultant Sai Casula. Unencumbered by carriers and third parties, virtual wallet makers are finally seeing the light at the end of the tunnel.

At the same time, consumer attitudes are slowly changing. Starbucks’ pay-and-go loyalty app has over 10 million users, demonstrating people’s willingness to embrace smartphones for mobile payments, if only for their morning lattes. Around the world, tap-and-go credit cards have also proliferated, with MasterCard, Visa and American Express all offering competing versions, which has helped allay consumer concerns over the security and privacy of “contactless transactions.” Meanwhile, tap-and-go NFC terminals are becoming increasingly common in stores, not to mention in taxis, in subway stations and in other venues where speedy payment is a priority.

But the real tipping point for virtual wallets may well come with the iPhone 6, whose release is rumored for later this fall. Consensus among industry analysts is that the new phone will have an NFC chip, paving the way for tap-and-go payments. (Even if that doesn’t come to fruition, the company has already rolled out related technology, iBeacon Bluetooth, in its iOS 7 operating system).

Indeed, Apple seems to have all its ducks in a row for a headlong plunge into the virtual wallet space: hundreds of millions of users’ credit card numbers on file; a device people carry with them at all times to hold these numbers; and even a fingerprint system to authenticate transactions (ensuring that stolen iPhones, for instance, can’t be used for payments). “Apple is absolutely the sleeping giant in the payments world,” explains Forrester Research’s Denee Carrington. “They have the capability; they just haven’t tied it all together.”

Just what an Apple wallet might look like remains conjecture, though many analysts suspect it would fit nicely within the iPhone’s existing Passbook app (used for storing things like boarding passes, movie tickets and gift cards). What is clear is that Apple has already made overtures to industry that it’s keen to handle payments for physical goods on its devices and CEO Cook is hardly button-lipped on the subject: “[You] still have a wallet in your back pocket and I do, too,” he said to analysts, “which probably means it hasn’t been figured out just yet.” Here’s betting that Cook and the best minds at Apple have set their sights on figuring out the virtual wallet riddle sooner rather than later.

Michael Gokturk (@MichaelGokturk) writes on mobile payments and is founder of Payfirma, a cloud-based platform that lets retailers process payments made online, in-store and via mobile device.