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By Nikita Aggarwal. By reducing upfront frictions and shifting and shrouding costs, smooth finance both increases risk in the system and concentrates risk in younger, less financially sophisticated, lower-income consumers, who are less able to absorb the risk.

At the heart of the Silicon Valley playbook is the mantra of frictionless-ness. It tells us that all products and services should be simple, seamless, smooth—without “frictions” or “pain points” for the user. This mantra has, in recent years, found its way into consumer financial markets, in a growing trend of frictionless finance.[1] In retail investment markets, popular apps like Robinhood optimize for frictionlessness—for example, by eliminating trading commissions and lengthy account verification procedures, enabling smaller investments in fractional shares, and by deploying a simple user interface and experience (UI/UX). In consumer credit markets, a key design principle of popular “pay in four” buy now, pay later (BNPL) credit products is to reduce user friction in online borrowing and payment—notably, by eliminating interest, streamlining credit-checking, and seamlessly integrating online finance and commerce (a trend referred to more broadly as “embedded finance”). BNPL is following the lead of popular online retail platforms, like Amazon, which embody the mantra of frictionless-ness in features such as “One-click” payment. 

zero-interest credit and zero-commission trading apps have made it much easier for consumers to borrow and invest.

By removing upfront frictions, and reducing transaction costs, zero-interest credit and zero-commission trading apps have made it much easier for consumers to borrow and invest. No doubt, this has potential economic benefits, particularly by expanding access to financial services for previously underserved populations. BNPL is, on average, cheaper than credit card borrowing. But access to finance is not an unalloyed good. Borrowing and investing are risky activities. Consumers can lose as well as gain money, and if the losses become excessive or systemic, they can jeopardize the health of the broader financial system and economy.

The aesthetic of frictionlessness exacerbates these risks. Eliminating upfront costs, such as credit interest and trading commissions, creates the mirage that borrowing and investing are costless—free. As retailers and advertisers have long understood, the human brain is hard-wired to think less reflexively and over-consume products that are free. However, these costs are not so much being eliminated as they are shrouded and shifted to other, less visible parts of the transaction. As a result, frictionless design is increasing the risk that consumers—especially younger, less financially sophisticated, and often lower income consumers—misperceive the true costs involved in financial transactions and make unfavourable financial decisions. In turn, by encouraging more risky borrowing and trading, frictionless finance both increases risk in the system and concentrates it in those consumers who are least able to absorb it.

Unsurprisingly, the aesthetic of frictionlessness can be very profitable for firms. Take zero-interest, pay-in-four BNPL. There are three ways in which the zero-interest BNPL business model shifts and obfuscates the costs of credit to the consumer. First, it shifts costs from the front end to the back end of credit transactions. Although these products do not carry any interest charge—which is typically more salient to the consumer—they do carry late payment fees, which are typically less salient. This type of behavioural manipulation is already familiar in consumer credit markets.

The second, less familiar shift is from charging consumers to charging third-party merchants or wholesalers. At its core, BNPL implicates a tri-partite arrangement between the borrower, lender, and merchant. The BNPL lender charges the merchant a transaction fee every time a customer makes a purchase using BNPL. These fees are typically high, however merchants justify them as BNPL can increase their sales (more specifically, a larger volume of smaller transactions) and attract a newer, younger consumer base (as well as their data—see below). Similarly, zero-commission trading replaces fees charged to consumers with fees charged to wholesale market makers (“payment for order flow”).

The third major shift is from monetizing the financial transaction (through the payment of interest and late payment fees, or trading commissions) to monetizing the data transaction (notably, for lead generation). To paraphrase Richard Serra, if something is free, you are the product. These latter transformations strengthen the incentives of merchants and lenders, in the BNPL context, and broker dealers and market makers, in the retail investment context, to increase transaction volumes—in turn further misaligning their incentives with the best interests of consumers, and the economy, in responsible borrowing and investment.

In a new paper, #Fintok and Financial Regulation, my co-authors Christopher Odinet and Bondy Kaye and I investigate the risks of BNPL using a novel dataset of TikTok videos in which creators discuss their experiences with Klarna, one of the largest providers of BNPL. Although our study is not dispositive, it conveys worrying signals about consumers’ misperceptions of the true cost of credit and resulting over-indebtedness due to BNPL, particularly among younger consumers. More broadly, zero-commission trading and the “meme stock” phenomenon has increased stock-market volatility. The shift under frictionless finance to a data monetization business model also introduces new financial and non-financial risks due to the misuse of personal data.

A perennial debate in financial regulation concerns the appropriate locus of regulatory intervention. Should regulators intervene in the design of products or focus on firms’ conduct and outcomes? Should they intervene ex ante or ex post? Over the last twenty years, the behavioural law and economics movement has highlighted the important role that choice architecture plays in consumer decision-making, leading to exuberance for more design-based and behaviourally informed financial regulation

Although it is inevitably a fine balance, some online friction that forces consumers to reflect more carefully on risky financial decisions is likely to be both economically and socially valuable

Given the inherently behavioural motivations of frictionless finance business models, a natural locus for regulatory intervention would seem to be the design of digital financial apps—more particularly, their frictionless design. Indeed, regulators—such as the SEC, CFPB, and FTC in the US, and the FCA in the UK—are increasingly alert to the role of deceptive digital design, including in consumer financial markets. Although it is inevitably a fine balance, some online friction that forces consumers to reflect more carefully on risky financial decisions is likely to be both economically and socially valuable. Architecture-based interventions in this vein could include: a requirement that BNPL is not a default payment method on retail platforms (an approach taken by regulators in Sweden); making information about late fees more prominent on the BNPL lender’s app or website; and removing or de-prioritizing statements that these products are “interest free.”

The political feasibility of these design-based regulatory interventions will vary between jurisdictions. Particularly in the US, they could raise objections on grounds of paternalism and infringement of individual constitutional freedoms. More broadly, design-based interventions, as with other forms of technological regulation, carry the risk of obsolescence and under-inclusivity. As such, it is important that design-based interventions are evaluated alongside, and complemented by, more traditional conduct-based interventions. This includes requiring BNPL credit providers to ensure that the claims they make to consumers are not misleading or deceptive, to carry out appropriate creditworthiness (ability to pay) and identity verification assessments, as well as encouraging them to share BNPL credit data with credit bureaus to facilitate a more complete assessment of a consumer’s ability to pay. In retail investment markets, potential regulatory interventions include increasing transparency and price competition in equities markets, and strengthening the duties of care of broker-dealers


By Nikita Aggarwal is a Postdoctoral Research Fellow at UCLA’s Institute for Technology, Law and Policy.

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[1] Frictionless finance is inevitably a subcategory of automated finance, under the broader fintech paradigm. This post focuses specifically on the behavioural implications of frictionlessness as a design principle in consumer financial markets, and in turn the implications for financial regulation (cf. Hillary Allen, Driverless Finance).

This article features in the ECGI blog collection Technology & Governance

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