The Payment Card Industry’s weird business model is a work of genius
Regular readers will know that I am extremely optimistic about the long-term potential of Bitcoin and cryptocurrency technology to revolutionise the financial system. But that doesn’t mean I think they will overturn all aspects of the system.
In particular, I am skeptical of claims that Bitcoin will have a meaningful impact on retail payments and break the stranglehold of the payment card companies.
Of course, many people disagree with me. Articles such as this one from last year are typical of the genre: “credit card companies” are accused of charging obscenely high fees, hindering innovation and being ripe for disruption.
Payment Cards fees might seem expensive but does it mean they are vulnerable to disruption?
Now, it’s true that the fees do seem expensive at first glance but, as David Evans has argued, it’s not obvious that the Bitcoin payment processors are really that much cheaper, once you take into account their spreads and the costs of getting into and out of Bitcoin at each end.
But the main reason I think the incumbents are in such a strong position is because the industry has extremely strong network effects, which leads to formidable barriers to entry. Would-be Bitcoin entrepreneurs need to understand this structure if they are to succeed.
The Payment Card Industry is marvellous and weird at the same time
When you step back and think about it, the modern payment card industry is a marvel – an underappreciated, underrated miracle of contemporary commerce: you can travel to any corner of the earth, armed only with a piece of plastic bearing the Visa or Mastercard logo. It’s a minor miracle.
But when you look at the businesses of the major card brands, they turn out to be really, really strange companies. They simply don’t do what most of us think they do.
Take a card out of your pocket… chances are, it will be a Visa or Mastercard, or maybe UnionPay if you’re one of my Chinese readers. Let’s assume it’s a Visa card for now. And we’ll worry about American Express later, because they’re different to all the rest.
Here’s one of my Visa cards again:
A Visa debit card, issued by first direct bank.
Notice something strange. There are two brands on the card. There is the Visa logo and there is one for first direct, the division of HSBC with whom I hold my current account. Most other consumer products don’t have two firms’ logos on them. Something strange is going on.
Now, it it was first direct that issued the card to me, not Visa.
It is first direct’s website I visit to see my balance, not Visa’s
And it’s first direct I would call if something went wrong, not Visa.
I don’t have any relationship with Visa at all.
There’s no Visa call centre I can call if I have a problem with my card and there’s no Visa app on my phone. This is strange: a hugely powerful global brand and yet the billions of consumers who use it don’t have a relationship with them.
It gets stranger. Another little-known fact is that no retailer anywhere in the world has a relationship with Visa either! So we have one of the world’s most recognizable brands and nobody who uses their “product” has any relationship with them.
It’s worth thinking through why this might be and why it is such a powerful model.
How would you build a credit card system if you were doing it from scratch?
Imagine you run a bank in a world before credit cards. Wouldn’t it be great if your customers could go to local shops and “charge” their purchases to an account that you hold for them? You could make money offering credit to the customers and make some more money charging the merchants for providing this service.
This is what Bank of America did in California in the 1950s. They issued credit cards to lots of their customers in various cities and signed up local retailers to accept them. Great – the payment card industry was born! You could think of the model looking something like this:
A simple card scheme: a bank issues cards to its customers and reimburses local merchants who accept those cards
But this model has two really unfortunate problems:
- Your competitors are going to copy this and you’ll soon have schemes like this popping up all over the country, all run by different banks, on different systems, racing to sign up consumers and merchants onto their product
- Your customers will travel. And they will be very upset when they discover they can’t use your card in a merchant who only takes a different bank’s cards
You would end up with the situation in the diagram below: a merchant who banked with Bank B wouldn’t accept cards issued by Bank A. Why would they? They had no relationship with Bank A and who’s to say cards from Bank A would even work with their machines?!
Why would cards issued by Bank A be accepted by a merchant who uses Bank B if Bank A and Bank B operate competing schemes?
If you were running one of the banks, how might you respond to this problem?
One answer might be to view this as an arms race: perhaps the best strategy is for banks to enter an all-out war… sign up as many merchants as they can… sign up as many customers as they can and bet that you’ll be the last firm standing when the industry shakes out. Obvious problem: it would be ruinously expensive and what happens if it ends in stalemate? You still have the same problem.
But there’s another option… what if you cut deals with other banks: agree for them to accept your cards at their merchants in exchange for you accepting their cards at your merchants. This sounds quite promising but… obvious problem: how on earth would the merchant handle this? They’d need a huge book by every till that listed precisely which banks they could accept card payments from and which ones weren’t allowed. It would be chaos… But perhaps it points the way
A flash of insight – who are you really competing with?
Let’s recap: you’re a bank executive trying to build a payment card business. But your competitors are all trying to do the same and it’s going to end in tears: you’ll confuse the merchants with hundreds of different card types or you’ll go bankrupt trying to be “last man standing”.
It feels like having other banks accept your cards at their merchants would be good… but how to make it work?
And this is where a flash of insight changed the world.
Somebody realized that the cards “business” was actually two businesses.
The first business is all about offering credit to your customers, managing their accounts and processing their payments. We could call this card issuing.
And the second business is all about enabling merchants to accept card payments and get reimbursed. We could call this merchant acquiring.
Aside: we call it “acquiring” because it’s helpful to model the card payment as a receivable that the processor purchases (acquires) from the merchant at a small discount, which you can think of as the processing fee.
This is the key point: issuing and acquiring are totally different businesses which don’t compete with each other.
Sure… all the issuers compete with each other.
And all the acquirers compete with each other.
But the issuers don’t compete with the acquirers.
Indeed, they have a really strong incentive to co-operate… the issuers want all the acquirers to accept their cards… and the acquirers want to offer their merchants the ability to accept as many cards as possible.
So let’s imagine a group of issuers teamed up with a group of acquirers. And imagine they agreed that the acquirers would all process the cards of all the issuers in the group: every issuer’s card would be accepted by every acquirer. They could use this forum to hammer out some standards: they would agree a common way to process cards, timescales for reimbursement, rules for what happens if something goes wrong… they’d define a “scheme”.
Now… this scheme would need two things: consumer recognition and merchant recognition. Consumers would need to know their card would be accepted at a participating merchant. And participating merchants would need to know a given card was part of the scheme.
So we need a brand. This brand would be something you could put on the cards and place in the shop window. It is how a merchant would know an issuer’s card was part of this scheme and it is how card holders would know a merchant was able to accept cards from that scheme.
One of these schemes is, of course, Visa. Another is Mastercard. And so on. And this is why cards carry two brands…. One to identify the issuer and one to identify the scheme.
In this way, the card schemes have created a system that allows merchants, who only have a relationship with their own bank, to accept payment cards issued by hundreds of other banks, without having to have any relationship with those banks at all. The only thing that matters to them is that the issuer’s card is issued on the relevant scheme.
And this model has really strong network effects… the more issuers and acquirers in the scheme, the more useful the scheme is to card holders and merchants. It’s self-reinforcing.
Talk is cheap… how does it work in practice?
OK. So we have a paper agreement that says an acquiring bank will accept any valid transaction made with a Visa-badged card. But how? How do they get approval from the issuer for the transaction? How do they get reimbursed? How does it work in reality?
Do all members of a scheme have to have a relationship with every other member so they can route the transaction to them for payment? That would be expensive and error-prone.
So this is where the scheme re-enters the picture. In addition to maintaining a powerful brand and setting the rules, they also run a switch: the merchant acquirers send all their Visa transactions to Visa itself… and Visa then forwards them on to the appropriate issuer. Similarly for Mastercard and the other schemes.
So we end up with a hub-and-spoke model… with Visa at the centre. (And Mastercard and Union Pay and so forth).
Issuers and Acquirers are members of a “scheme”, which sets the rules and acts as a central “switch” to route transactions. It means merchants with one bank can accept payments from customers of another bank, without having to maintain bilateral relationships
So now we can see why card schemes are so successful: their globally-recognised brands create networks that anybody aspiring to issue or process cards need to be part of. It’s a self-reinforcing virtuous circle that is extremely hard to disrupt
And this is why Visa’s “customers” are the issuing and acquiring banks… not end-consumers… Visa exists so that issuers can receive broad acceptance of their cards… and so that merchants can, in turn, offer broad acceptance.
But the schemes depend on consumer recognition – hence why they spend so much money advertising to consumers, even though the consumers are not their customers.
What does this have to do with Bitcoin? Push versus Pull
Notice something really important: this is a pull system… the reason you need all this infrastructure is because your card information has to get all the way from the terminal in the merchant back to the issuer so the issuer can pull the money from your account and send it back to the merchant.
By contrast, Bitcoin is a push system: once you know the merchant’s “account” details, you can just push the payment to them. So why do you need all these intermediaries?
If you were a Bitcoin payment firm trying to break into the retail market, perhaps that’s where you’d start? After all, it’s true that most of the payment card infrastructure simply isn’t needed in the Bitcoin world.
But notice how I set up this story. The infrastructure was the last thing I talked about. For me, the two most important things are:
1) Global acceptance.
2) The rulebook
Think about what Visa and Mastercard have achieved: they offer global acceptance and predictable behavior. Wherever you are in the world, you can be pretty sure somebody will accept your card and you know how it will work and that there is a well-understood process when things go wrong. This offer is powerful. Ask yourself: if you could only take one payment instrument with you on a round-the-world trip, what would it be? If you couldn’t stake a stack of dollar bills, I suspect you’d opt for a credit card.
And this predictability – a consequence of the rulebook – is important: consumers enjoy considerable protections when they use a major payment card. They can dispute transactions and, in some countries, their (credit) card issuer is jointly liable for failures of a merchant. Consumers like to be nannied… even if they have to pay for the privilege!
So for those who aspire to overturn the incumbents, you need a strategy for how you will become the consumer’s “default” or preferred payment mechanism.
American Express has achieved this through a joint strategy of having large corporates mandate its use for business expenses and offering generous loyalty benefits to consumers… they effectively pay their customers to use their cards.
PayPal has achieved it through making the payment experience easier – but note, even here, many PayPal payments are fulfilled by a credit card account!
And this is why I harbor doubts about whether Bitcoin will become a mainstream retail payments mechanism, at least in the major markets… why would a consumer prefer it over their card? Perhaps the openness and possible resistance to card suspension/censorship will attract sufficient users. But it’s not obvious.
For me, the opportunity lies elsewhere: high-value payments, smart property and so forth. But I could, of course, be wrong. It wouldn’t be the first time…
An aside on history and factual accuracy
I know this account would scandalize a historian but that’s OK: It’s not intended to be historically accurate… the idea is to share intuition on why things are the way they are.
Some of the more important topics I’ve ignored or deliberately simplified include:
- I’ve not explored the difference between Visa Inc (public company) and Visa Europe (owned by its members)
- I’ve ignored the “three-party” schemes like American Express.
- I’ve also ignored fee structures and the importance of interchange.
- I’ve also not discussed the role of processors… specialist firms who effectively outsource the work of issuers and acquirers
- Security
- … and lots more
Richard Gendal Brown 
Imagine a world where the US dollar inflates about ten thousand percent over the span of a few years. Will people want to use their Visa card if the value in their account drops about a percent a day ?
If bitcoin truly succeeds and takes over small commerce payments, it will be because the old system failed, not because it was more attractive to consumers.
Just to try and fit Bitcoin into the framework you described….
So, the issuer is the service that the consumer uses to buy bitcoins (perhaps an exchange such as Bitstamp); the acquirer is the payment processor used by the merchant (at the moment probably Bitpay or Coinbase).
Bitcoin works both as a scheme, and as a brand, and it has global acceptance. I can use my bitcoins at any merchant anywhere in the world where I see the Bitcoin logo, regardless of where I bought those bitcoins and without having any relationship with the payment processor the merchant is using.
And the Bitcoin protocol is the rulebook. It states, amongst other things, that all transactions are final.
It seems pretty similar, overall. The big difference is that consumer protection isn’t handled by the rulebook. Yet. But that doesn’t mean it never will be, e.g. perhaps by incorporating optional escrow providers into the payment protocol. Granted, it’s not quite the same, but I’m not sure it’s as different as you suggest, either….
roy
Rewrite this post in 10 years. The greatest thing about innovation is that it finds solutions to problems we see, and the problems that we can’t see until they are solved. I’m sure in the beginning of the credit card era, many thought it would never take off. It is too early in Bitcoin’s life to think about anything else other then supporting its innovation and evolution. Try not to pigeon hole Bitcoin before it has a chance to flourish.
Interesting read.
The thing about bitcoin is that the clear distinction between “customer” and “merchant” breaks down completely. Anyone can be either, therefore there is actually no need for a “complex payments system(s)” .
This should not be underestimated.
-Codehalo
I am a big fan of Occam’s Razor.
Hi Roy,
Thanks for the comment. I’m not actually sure Bitcoin fits into the model I described. My mental model for payment cards is as “pull” schemes. In pull schemes, the assumption is that the merchant and associated infrastructure is completely trustworthy… and it is the consumer that is required to authenticates to the (assumed trustworthy) merchant – they do so using chip/pin/signature/id/whatever. The merchant, once satisfied that the consumer is legit, then uses the payment card infrastructure to pull the funds from the consumer’s account. That’s why we need EMV/PCI-DSS, etc.,…. if anybody in the infrastructure is a bad actor, the whole thing falls apart.
Bitcoin works the other way… Here, the merchant must authenticate to the consumer (i.e. it’s the merchant who tells you their bitcoin address – or asserts it via BIP 70 payment protocol)… and the consumer then pushes the funds directly to that address over the P2P network.
i.e. Bitcoin is more like m-pesa (or, for those in the UK, faster payments/Zapp/Paym).
So – a very different model…. and my take is that push is superior. BUT… the pull infrastructure, imperfect as it is, has HUGE sticking power (for all the network effect reasons I described in the article). A fascinating space 🙂
@ansel – a very fair point… when I speak to banks about this, I urge them to distinguish between “bitcoin as it is today” and “bitcoin/cryptocurrencies as it/they are likely to be in the future”… i.e. which limitations are innate and which will be fixed in time?
An interesting analysis of the payment card system.
You summarise with this:
“And this is why I harbor doubts about whether Bitcoin will become a mainstream retail payments mechanism, at least in the major markets… why would a consumer prefer it over their card?”
I think the answer is that consumers will prefer to pay using Bitcoin rather than pay by some other method because they will want Bitcoin to succeed. As supporters of Bitcoin, they will seek out merchants who accept Bitcoin and pay by that method as a result.
Why would someone want Bitcoin to succeed? There are various answers. Some support Bitcoin for reasons of political ideology. Many support Bitcoin because they have been persuaded by the plausible arguments that bitcoins could one day be worth a vast amount more than they are today, and so they have bought bitcoins as an investment. Now that they have a vested interest in Bitcoin’s success, they will opt to give their custom to those businesses that let them pay using Bitcoin, buying with bitcoins and replacing what they spent by buying some more bitcoins at the same time.
The Bitcoin community is, at present, still very small in global terms. But it is growing. We are still at an early adoption stage. No-one knows for sure what will happen to Bitcoin, or its exchange rate to fiat. Investing in Bitcoin is risky. But the potential returns for early adopters if Bitcoin does go mainstream are huge. The realisation that if they get in now at the early adoption stage they could see major returns on their investment is likely to create many more bitcoiners.
I believe it is this that will one day create a tipping point, with retailers moving to accept Bitcoin as a payment method – because they want all those bitcoiners to be customers of their business, not their competitors.
This is a great read but I can’t help thinking that the claim about bitcoin is getting it’s reasoning wrong.
The reason why Bitcoin might have some way to go is not because it’s not Visa og Mastercard but because it’s not FIAT currency and because neither Visa nor Mastercard accept bitcoin. If they did problem would be kind of solved.
Plus any scheme trying to make it will have problems with acceptance. Discovery, Diners card etc. all fighting battles of acceptance.
So although I think your historical walk through is correct it doesn’t really show why Bitcoin isn’t going to replace it. ANY new card issuer on the market will have problems replacing the existing Big 3 (Visa, Mastercard & American Express).
But other than that. Great read.
Did you happen to read this:
http://paymentsviews.com/2014/05/15/there-is-no-such-thing-as-an-international-wire/
@Thomas – thanks for the comment. Yes – I think I agree with you…. the problem of breaking into the retail payment space isn’t unique to Bitcoin…. *all* newcomers will struggle.
Your point about Fiat is also important and I guess it’s one of the big outstanding questions in the Bitcoin space: do we believe there will be a time when some/most people are happy to hold BTC rather than their native currency and use it to transact?
I don’t think the answer needs to be “yes” for Bitcoin to succeed (i.e. its other use-cases don’t require it to be a day-to-day currency) but I think Bitcoin retail payment solutions *do* need the answer to be yes… and I share your scepticism on that front.
Thanks for the link to Erin’s piece…. I really like it. I had tried to do something similar when I wrote this piece: https://gendal.wordpress.com/2013/11/24/a-simple-explanation-of-how-money-moves-around-the-banking-system/ but Erin’s was much better!
Hi Gendal,
Insightful post. However I fail to understand why the push/pull dichotomy is so important. Consumers will use the most convenient and widespread way of paying, which is why most new payment technologies such as NFC have miserably failed so far.
In the next 5 years, almost everyone on Earth will be equipped with a smartphone that can host a Bitcoin wallet app. Scanning a QR code at a merchant is even more simple than paying by CC (no need for that damn terminal, many more customers can pay at the same time, no need to carry around a piece of plastic in addition to your phone).
As Roy said, Bitcoin acts as a brand as easily recognizable as VISA or MasterCard, and merchants can adopt it at virtually no cost. They get the additional benefits of less fees and more customers (unbanked). So I see no reason why Bitcoin couldn’t take on VISA provided that the technology scales.
I think your argument works better at describing why altcoins that don’t significantly differentiate from Bitcoin will all ultimately fail.
I’ve included it in the next issue of my newsletter, bitcoinweekly.
Most people (including many VCs investing in bitcoin companies) miss the fact that the historical ledger started by Satoshi and Hal Finney in 2009 is as important as the blockchain technology. Visa and Mastercard are not the first in line. Fiat currencies and especially the weaker can’t compete with Bitcoin over time. They will break before Visa and Mastercard, these actually have a chance to adapt, though I doubt they will.
Bitcoin is by far the best money. It’s not possible to understand bitcoin and not to see that it’s cars vs horses. This time we even built the roads (Internet) before. It should be obvious but then in 2014, in the developed world, you still have a majority of people who seem to think that we will still read on news and books on paper… Humans are not well equipped to see revolutions in the making.
Tji
I would still claim that the protocol is more important than any specific interpretation of it.
@stanislas – thanks for the comment.
My main reasons for raising push versus pull are 1) push has real problems at point of sale – what happens if the customer doesn’t have an internet connection? and 2) the threat model is completely different
The interesting thing to me is that 1) and 2) are in opposition. Point 1) suggests push payments will be resisted by retailers (too complex, what happens if there’s no signal? what happens if customer says they’ve paid but nothing is received, etc?) but point 2) suggests that the lower (or, rather, different) security risks (no need to trust the merchant/network, etc) will make it more attractive.
Time will tell!
@Tji – thanks for raising this. You’re right to point out that I didn’t engage with any question of Bitcoin-the-currency. My (unwritten) assumption was that fiat and BTC will coexist and so the decision of which system to use can be made on a case-by-case basis by the consumer. But, as you suggest, if Bitcoin-the-currency takes off, then the analysis is completely different
I follow the reasoning and it’s good but depends on what’s is the achieving of the “credit transportation system”.
If you need one between a person and a business P2B, yes credit card it’s good: but BTC it’s all about P2P.
If you need a system where the basic transaction is 10-50$ and it used 1-2 a day, yes, credit card it’s good: but BTC it’s all about little but frequent transaction, and, most important, automated transaction, and programmable!
I take an example: if you want to share you RAM over the internet (I know for now there isn’t a system for this) but let’s hypothesize: fast internet connection and a way to exchange computer hardware over the Internet (see also PlayStation 4), now you have P2P Hardware sharing all automatized, and you can have a supercomputer for the hours when you use it and no computer when you doesn’t use it! (Now we have an average computer all the time.)
Or let’s took another example: exchanging knowledge. Now we haven’t reliable systems to do that, apart for stackexchange and similia there isn’t a real P2P knowledge exchange system over the Internet, with Bitcoin you can set up an escrow and pay for aswers, pay for specific piece of knowledge, not buy and read an entire book just to see a page!
And the same with software usage, with journal usage and with all.
Basically money isn’t more a number but is a flux. Basically you haven more agglomerated called Business, but the Business structure it’s automatically matched on a P2P structure, that’s is a program.
Excuse if you already thinks things like these, I know you are a very good Bitcoin observer, on the other way, I’m happy to share with this thinks that maybe you haven’t pondered. We will have a completely shift in the social structure, so we need a change in the credit exchange structure.
Dear Richard- I am still stuck in my clearing bank scenario. I have read about CLS and it was very informative. If -CLS allows me to connect indirectly through a member bank which it does – this means I have access to all the banks CLS is interconnected with right? BECAUSE CLS has an account within the same central bank I have an account with – it makes it an account to account transfer within the same bank. Here is where it becomes confusing for me- If I communicate with my bank via a swift interface – using swift messaging for conformity – Do I really need to be having all the different bank relationships swift expects of a financial institution rolling out swift remit? They state that the first step is to establish your remittance corridor- then form a bilateral agreement with a bank in that corridor.- sounds like the correspondent banking fiasco to me. I hope I am not oversimplifying the process for myself.
One step further – If I want to send forex on behalf of a client in country A where CLS does not exist. I could open a local account in country A . As soon as client deposits money into my account in A – I would then remit from my CLS linked account on their behalf at a lower cost . An improvement on my scenario would be welcomed.
Mendi
Following up on your rhetorical question, “why would a consumer prefer it (Bitcoin) over their card?”, here’s one real world example of consumers doing just that:
“Since it started accepting bitcoin in November of 2013, CheapAir says it has sold $1.5 million worth of airline tickets, hotel rooms, and Amtrak tickets using the cryptocurrency, the company said on Thursday….
“…The bitcoin community has really embraced us for it, they’re extremely loyal, extremely passionate, and they’ve become great ambassadors for our brand,” Mr. Klee said, noting that building loyalty in his business is difficult, as customers are adept at shopping around for the best prices.” (from http://blogs.wsj.com/moneybeat/2014/07/17/bitbeat-bitcoin-and-wall-street-2-0/)
Why are such consumers doing this? Because they want Bitcoin to succeed, and so back the businesses that choose to back Bitcoin.
@mendi – thanks for the great questions. I’ll do my best to answer… but I should stress that I’m not an expert on how CLS works so some of this is supposition on my part.
Probably the key points to remember when thinking about CLS are:
1) that it exists to reduce the risks face by large banks from the failure of another large bank…. it’s to protect against systemic risk… it’s not intended for use by individuals.
2) it was created primarily to support payment-versus-payment transactions — where banks are swapping currency for another with each other. This contrasts with the payment scenarios I described where I was talking about payments: somebody sending a payment to somebody else. In the payment case, CLS doesn’t really help: my bank still needs to maintain a balance with its correspondent in the target country.
@steve – interesting example… thanks.
Hi Richard and All,
I’ll start by saying that hind sight is a wonderful thing. I’ve gone through the comments and my answer to a puzzle you raised will include previous comments.
The Blockchain can be the SWICTH in the model you described linking issuers and acquirers. Since Bitcoin doesn’t distinguish – it’s peer to peer – CodeHalo commented on this “clear distinction between “customer” and “merchant” breaks down completely” – the distinction between acquirer and issuer is lost. A QR code is all that is needed to receive payments.
Imagine PayPal acquires a payment processor like BitPay, acquires an exchange (CICO). PayPal then ‘rides’ on the Blockchain-SWITCH. PayPal can issue a ‘card’ or wallet app that allows consumers to pay any merchant with a displayed QR code or a Bitcoin Accepted here sign. PayPal will effectively compete with Visa and MasterCard on a lower cost network switch. Since merchants only need a QR code/smartphone to accept payment, there’ll be plenty of merchants using this method as an alternative.
Banks can now jointly issue PayPal ‘card’ or a wallet app that allows customers to move funds from Bank to Bitcoin (via PayPal) during purchases. PayPal will charge a fee (mostly BTC-USD FX margins). It can share this fee with Issuing banks.
Since a consumer can be a merchant and vice versa, acquirer and issuer become indistinguishable. Banks/PayPal will just have to convince everyone to use a jointly issued Bank-PayPal wallet app. Paypal will be in the FX business – BTC/USD/GBP and a host of foreign currencies depending on partnerships in those parts.
Like you said, push is better than pull. This is a push model.
Stanislas made a good comment about QR codes and the ease of accepting BTC. You replied – the presence of an internet connection might deter merchants from this method.
This can very easily be solved. The concepts of off chain transactions & side chains could offer solutions for this problem. Take a look at how change tip works, Reddit tip jars. A payment is a private key authorization for a set amount. No reason why it can’t work offline (Recall PayPal’s fingerprint biometric checkout feature on Apple). If the merchant accepts Bitcoin and consumer pays in bitcoin and both are on PayPal’s network, PayPal can step in and offer merchants assurance of offline transactions. They’ll in turn put in place features and work with the Blockchain SWICTH firms (eg blockchain.com) to enhance offline transactions. Offline transactions can be limited to low transactions (less than 50$).
PS: The use of ‘card’ represents a device. Not necessarily a plastic card.
I hope this convinces you that it’s a real possibility.
@Gendal: Excellent article as always, I have become a fan of your blog!
There is another potential black swan apart from Bitcoin in the game. That is the appearance of banks that represent their liabilities / assets in public cryptographic ledgers with inbuilt scripting languages.
If this happens, interesting possibilities open up. For example, it becomes possible to do decentralized exchange of assets from one bank to another. Let’s say Bank A runs ledger A with Alice as customer. Bank B runs ledger B with Bob as merchant.
There can be a decentralized exchange market places where Alice can acquire assets on Bank B’s ledger in under 10 seconds by decentralized exchange with a market maker. Market maker facilitates multiple trades like these and profits through tiny spreads. Alice pays Bob directly without needing a service. Downside is an international transaction with multiple hops may take a minute.
I am writing an article attempting to conceive what this game would look like. I would be pleased if you could read it. There are many gaps in my knowledge, and having someone as yourself review it will be invaluable.
https://docs.google.com/document/d/14kPffQHRyJ3Q9dGGpw7hzjlEOAXVoCM3VEHj_HXgjzs/pub
@Meher – thanks…. 🙂 I’ll take a look at the paper. I’ve asked for edit permission so I can make comments in line if that would be helpful.
Retail really isn’t where Bitcoin shines. For one, a merchant accepting a Bitcoin payment immediately is taking the [usually minimal] risk of a double spend. There are some approaches that can try to minimize that (e.g., monitoring nodes to detect attempts, etc.) but it can still be a problem — especially if a mining cartel is aiding it. Another reason retail payments isn’t a good match for Bitcoin is its scalability limit. Until solutions that can handle much larger transaction volumes emerge, only a tiny percent of today’s retail transaction volume could fit on the blockchain before limits are breached.
But there are enough incentives for a merchant to prefer Bitcoin payment that we may see pockets of traction emerge. Just like the petro station gives a discount for cash-paying customers, you may find merchants do the same with Bitcoin — especially when payments cards are not idea, such as where customer chargeback levels are high (e.g., travel industry).
Nice article. I can’t help think about my Starbucks app. I prepay $100 on my virtual Starbucks card in the app, and the baristas just scan my app’s barcode. Of course, all this is managed via a credit card. The convenience is great — but only at Starbucks! I would much rather use a smartphone bitcoin wallet anywhere. But as your article points out, there is no “acquirer”. But I can imagine either Visa or MasterCard buying BitPay or CoinBase (or even Circle) To preempt their rival. They could reduce the merchant fee by a substantial amount (and still keeping it higher than it needs to be and still offer some merchant services), and they would cut down their costs significantly.
For sure, there would need to be a re-positioning of what the service is. Essentially it becomes a “secure, be your own bank, debit card”. But the real challenge is how the banks would react, since their whole usurious credit business would essentially be attacked.
Other issues, not the least of which are BTC exchange rates and fees, would need to be considered. But I can image a bold move such as this being discussed in the back rooms of Visa or MasterCard.
One additional thought… It occurred to me that the new merchant services for Bitcoin will become an insurance play — essentially reducing the risks and uncertainties for the merchant.
As I’ve always warned. I’m a payments guy. Never got why people looked at bitcoin as replacing cards. Lightening is an interesting concept… The one thing this post misses, is the gap between auth and settlement.
Bitcoin as a giant settlement engine could be interesting, but is it not more likely visa would distribute their network into a replicated shared ledger for improved settlement?
It wouldn’t compete with today’s auth speeds… But it would make settlement and especially disputes chargebacks more interesting
> push has real problems at point of sale – what happens if the customer doesn’t have an internet connection?
A couple of points here:
1) You’re really looking backward, not forward.
2) The problem exists on the merchant side as well: It’s not uncommon to be told “sorry, our terminal is down, we cannot accept cards right now…”
@nickp – the insurance angle is one I think could have legs… i.e. the merchant pays a fee to the processor to guarantee that a transaction won’t be double-spent.
Great post as usual.
Why are the fees higher for using cards than cash?
@samjgarforth.
Thanks Sam! I wrote a separate piece on fees here: https://gendal.me/2014/08/09/a-simple-explanation-of-fees-in-the-payment-card-industry/
Additional thought: is it immediately obvious that cards (at least debit cards) *are* more expensive to merchants than cash once the real, but often unseen, costs associated with cash are taken into account?
Yes, that was my point. I understand that there are costs associated with processing cards but surely they must be lower than the costs of processing cash?
Interesting read. Visa has started to explore push payments with the launch of mVisa in India. The consumer scans a QR code from their banks mobile banking app and money is pushed from the customers bank account to the merchants bank account using an OCT message.
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