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Google is working on a mobile-payment wallet and advertising service that could launch this year, enabling consumers to make purchases by tapping their NFC-enabled Android phones, sources told NFC Times, following an article today that the Web giant was considering the move.

It’s unclear, however, if Google and its partners launch the service, how they would overcome the formidable challenge of building an acceptance infrastructure at the retail point of sale. That would be a problem whether Google tries to launch its own payment scheme or–more likely–if Google partners with established payment networks. Fewer than 2% of merchant terminals in the United States are equipped to accept contactless payment from any brand, including Visa and MasterCard Worldwide.

"Gaining merchant acceptance is always one of the cardinal challenges of getting a two-sided market, consumers and merchants," Todd Ablowitz, president of the U.S.-based payments consulting company Double Diamond Group, told NFC Times. "If you look at it, Google has a tremendously powerful consumer relationship, so it’s not a big stretch to say Google would have an easier time on the consumer side than on the merchant side."

He believes Google would likely enlist the support of an established payment card network. And a source, who asked to remain anonymous, told NFC Times that at least one U.S. bank is involved with Google in the NFC payment plan. The Web giant has had a team of perhaps two dozen employees working on NFC-based mobile commerce, he added.

The article today, published by Bloomberg Businessweek, cited two unnamed sources familiar with Google’s plans for a mobile payment and advertising service for phones running on the company’s Android operating system. The service would put payment, gift card, loyalty and couponing applications on a chip in the phones and could include online purchasing in addition to NFC-based proximity payments, according to the article.

Update: Sources, however, now tell NFC Times that Google is actually working on mobile-wallet software for its next Android operating system and has sought to interest major U.S. banks in putting their credit, debit or prepaid applications in it. These applications would support MasterCard PayPass or Visa payWave. End update. 

In addition, the Bloomberg article quoted Laura Chambers, senior director of PayPal Mobile, as saying the Internet payments company "may start a commercial NFC service in the second half of 2011." Update: A representative from PayPal told NFC Times that Chambers was misquoted in the article. The official statement from the company is that "PayPal may start testing an NFC service in the second half of 2011." End Update.

PayPal, which is seeking to make the jump to the physical point of sale, would be open to working with such companies as Google on NFC payments, Chambers said, according to the article. Of course, PayPal has already been open to working with a number of companies willing to develop on its PayPal X platform and plug into its payment system.

Some others believe Google would use its Google Checkout or some type of cloud-based online payment system by adding the proximity piece at the physical point of sale that NFC offers. The payment might be initiated with a tap of the phone on an NFC tag. But processing payments over the Internet would be too slow at many retail tills, some believe.

Mobile Ad Focus?
But observers believe that Google is more interested in the revenue possibilities from mobile advertising–similar to its revenue model on the Internet today–than on payment. Google, for example, could send targeted promotions to consumers based on their mobile searches or even on their buying habits. Those promotions, including ads and coupons, could be delivered when consumers are in the store, using GPS and NFC’s tag-reading capabilities. In return, Google could charge consumer products companies, merchants or banks handling the mobile payment.

Google last month introduced its own NFC-enabled smartphone, the Nexus S, which supports the latest version of the Android operating system, dubbed Gingerbread. In November, Google CEO Eric Schmidt publicly endorsed NFC and said the technology in mobile phones "could replace your credit card." He did not say anything about Google getting involved in payments directly.

The Gingerbread software at present only supports NFC tag-reading applications, but Google has indicated there is support to come for more applications, which presumably would include payment. The Nexus S reportedly sports an embedded secure chip that could store such applications as payment on the phone itself. It would be possible to store secure applications on SIM cards in the phone, as well.

Embedded secure chips are expected in other Android NFC phones, but if Google and its partners in any mobile-payment service attempt to take control of them, it could create friction with U.S. mobile operators, which plan their own NFC-based m-payment service, called Isis.

Who Controls the Embedded Secure Chip?
It remains to be seen which parties will control the embedded chips, but U.S. telcos, which will buy the Android NFC phones to resell to subscribers, will have a strong claim to them. They might insist on control of the master keys to these chips and could use that control to dictate terms to banks or other payment service providers, such as Google, or even lock them out, said some observers. Operators will have even more control over NFC-enabled SIM cards, which they will issue.

Google, which is selling the Nexus S both independently and with a mobile operator, would most likely remain in control of the embedded secure chip.

"It’s not clear what the U.S. carriers will do as it relates to specifying the use of the secure element," said Ablowitz, a former executive with U.S.-based contactless reader and NFC company Vivotech and a former manager at big U.S. processor First Data. "There are moves and countermoves we're seeing. This is a chess match."

These issues probably have come up during quarterly meetings hosted by bank regulators of the U.S. Federal Reserve the past year. Besides representatives of major telcos and banks, a source said a representative of Google has attended the non-binding discussions, along with representatives of trade organizations, card schemes, processors and vendors.