Tuesday , February 18, 2020

A Slow-Acting Poison

For centuries, consumer credit was extended via a bank loan, which overtaxed borrowers to pay interest from day one. Businesses, though, were extended a line of credit on which they drew as needed, and they only paid interest from the moment they used the money.

Then, in the late 1950s, some creative characters at Bank of America came up with a brilliant and simple idea: Offer consumers the same convenience enjoyed by businesses. And the credit card was born.

Implementing the idea was a challenge. How to convince a merchant that he will be paid later for the merchandise he gives out today? Dee Hock, the man in charge, came up with the remarkable idea of branding. He prevailed on an ever-growing number of banks to join in with what eventually became the Visa network and market their consumer credit under a single, unifying brand name. Then all Dee had to do was to induce a few merchants in any given market to place the Visa emblem on their shop window.

Consumers gravitated towards the option to buy now and pay later. In fact, they walked out of stores that did not accept the card. For merchants, it became a must for survival, and they lined up to accept Visa. Throughout the second half of the 20th century, the Visa brand expanded virally.

For decades, the modus operandi of not only Visa, but MasterCard, American Express, and other such brands was based on ever-evolving policies that assured merchants that the brand would stand behind the transaction.

No bank could compete outside the network because the branding was the pivot of the operation. And the branding was necessary. Without it, the merchant would assume too much risk. The network came to dominate payments throughout the world. Competitors were thwarted.

When Visa was launched, the prime office machine was the typewriter. Technology kept challenging the network, but, remarkably, it was quick to adapt and stay on top. When RSA and Diffie-Hellman developed the cryptographic foundation for online commerce, the network reinvented itself. Just yesterday, merchants had to scour through densely printed booklets of revoked accounts. And if they accepted a card that was on that list, they were responsible, not the network. Technology changed this. Now, merchants get a pre-authorization before they release the merchandise.

Alas, this “progress” may just be an irreversible injection of slow-acting poison into the veins of the networks. Consider this: Technology has removed the merchant from the risk map. Merchandise is paid for, or the payment is guaranteed by a trustworthy party.

Hitherto, the merchant relied on a non-specific, conditional guarantee that could be voided under a variety of “non-compliant” actions by the merchant. Today, the guarantee refers to a particular transaction. Anything suspicious about the transaction is apparent to the issuer, and factors into the decision to authorize payment.

The merchant no longer cares, nor should he care, whether the agent who paid for his merchandise is a member of the Visa network, or a non-member bank, or indeed a reputable financial entity. And for any actual payment, the merchant may not even wish to know who the payor is.

This shift in risk allocation is the slow-acting poison for the networks. Over time, entrepreneurs, shunning the networks, will use this shift to offer consumer credit. The merchant will accept payment from them, too, and why not? The risk for the consumer’s eventual payment is better borne by entities other than network members. The best home for that risk is the consumer’s employer, who might deduct monthly payments along with the taxes. Municipalities, or utility companies that can deny essential services (for example, water) are also better positioned than a far-away bank relying on a credit score.

The advent of digital money will facilitate instant e-cash payment to the merchant, be it from a far-away country (we are all neighbors in cyberspace), or from an undisclosed source.

Long-time edifices have been recently replaced by ad hoc substitutes like direct charity and crowdfunding. Nonbank credit is part of this trend.

There will be no big bangs, just a slow erosion of the brilliant concept that ruled the payment world for more than half a century. The networks will fight hard, and choke-lobby the regulators, but technology will win.

–Gideon Samid, Gideon@BitMint.com

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