Jack Dorsey on Square, How It Works & Why It Disrupts

Square CEO & Co-Founder Jack Dorsey. Photo by Bijan Sabet.

In February 2009, Jim McKelvey, who’d left the technology business and became a glass blower, lost an order because he couldn’t accept a credit card from a customer who wanted to buy his creation. He called his friend and Twitter co-founder Jack Dorsey. The two talked about lost opportunities in the current payment ecosystem that is dominated by giants such as Visa, MasterCard and PayPal.

Within days McKelvey left St. Louis, moved to San Francisco to team up with Dorsey and Tristan O’Tierney and start working on what would eventually become Square. It took them a month to cobble together a working prototype. Dorsey worked on the back-end server, O’Tierney on the iPhone app and McKelvey worked on the hardware and on establishing relationships with payment partners.

“We went through the whole payments process and worked on designing a brand-new (person-to-person) payment system,” said Dorsey in a conversation earlier today. The San Francisco-based startup today came out of stealth with a tweet by Dorsey.

What Is Square?

It’s essentially a small magnetic reader that plugs into the headphone jack of an iPhone. When a credit card (or a debit card) is swiped through the reader, it reads the data and converts it into an audio signal. The microphone picks up the audio, sends it through the processors and then is routed to Square’s software application on the iPhone. From there the encrypted data is transmitted using either Wi-Fi (for iPod touch) or a 3G Internet connection to back-end severs, which in turn communicate with the payment networks to complete the transactions.

“We don’t store any information on the devices,” Dorsey said. And because this tiny white reader, which is small enough to hook up on a keychain, uses the headphone jack, Square can work with any device: Android, BlackBerry, Symbian Phones and even computers. “As long as we have software on that device, our reader works,” said Dorsey. Right now, they only have software for the iPhone & iPod touch. I have seen Square working at Dorsey’s café, Sightglass (my new favorite in San Francisco), and it works as advertised.

Who’s Square For?

When I asked Jack if this was a tool and a service for merchants or consumers, he answered “for both.” Dorsey has big ambitions and wants to enable a people-to-people payment system that marries the convenience of “plastic” and “mobile devices” for everyday transactions. He noted that often on Craigslist you buy something that costs a few hundred dollars -– say, a couch. Carrying that much cash for a purchase can be a risky. On the other hand, if the seller has a Square credit card reader and the Square app installed on either an iPhone (or an iPod touch), then she can easily accept credit cards.

Square owners are authenticated and attached to a bank account, much like PayPal. Dorsey said the company is working hard to reduce the time of authentication to a few minutes from a couple of days. The rest of the payment process is pretty similar to PayPal. You get an SMS and an email with confirmation and the details.

While I applaud the idea of everyone owning a Square device, the hurdles are manifold. Square would need to support many different devices. Having followed the wireless industry long enough, I can tell you that building and supporting an application for different platforms is as tough as climbing a straight wall of rock.

In comparison, merchant adoption of Square would be a no-brainer. When I visited India, I came across pizza deliverymen and grocery store delivery folks who carried a wireless-enabled credit card machine, which essentially did what Square does. In cities like New York, it is common to find taxicabs with wireless-enabled card readers. Square takes it one step further and turns any wireless device into a card reader.

Why Square Exists & Who Should Be Worried

I think that this is truly disruptive. The reason Square exists is because of three macro trends: the pervasiveness of the mobile Internet, the increase in the use of electronic payment systems and most importantly, the availability of low-cost, always-on computers (aka smartphones) that allow sophisticated software to conduct complex tasks on the go.

The marriage of computing and connectivity without the shackles of being tethered to a location is one of the biggest disruptive forces of modern times. It is (and will continue) to redefine business models, for decades.  Square is simply riding these waves.

My view is that Square (or something like Square) is going to disrupt the businesses of companies such as VeriFone and Symbol, a division of Motorola that makes point-of-sale devices. Verifone makes a $900 wireless credit card terminal vs. Square, which runs on a $299 iPod touch. I rest my case. Will Square (or another Square-type company) be a success tomorrow? Probably not! But in a few years, the sheer economics of it is going to turn the tide against the dedicated hardware makers.

Dorsey, who was careful to stay away from naming his competitors, said his company’s focus is on software and making software do complex things. The software may add facial recognition capabilities, thus making the transaction process even more secure and painless.

What’s Next?

Square’s potential is such that the company is said to have raised about $10 million in funding from Khosla Ventures and several angels, including many Hollywood stars. Gideon Yu, former CFO of Facebook and now a partner at Khosla Ventures, is the one who invested in Square. Various sources in Silicon Valley attest that this has been a much sought-after deal for venture capitalists.

Many of them will probably have a chance to invest in this company. For Square, if it truly wants to deliver on its ambitions, will need more than just luck –- it will need capital. And there is no denying that the challenges facing Square are many. But the simplicity of the idea, the audacity of the company’s dream and the convergence of diverse technology trends make Square a company to watch.