Can Blockchain Introduce Competition in Payments?

U.S. merchants’ unhappy experience in payments is well known by now.  Take it or leave it interchange rates that are orders of magnitude higher than rates that prevail in other parts of the world.  An increasingly long list of opaquely described network fees, which are also take it or leave it propositions.  Indefensible extensions of the Honor All Cards rules to force merchants that implement contactless technology to accept third-party digital wallets.  The implementation of punitive rules, such as PCI DSS, which force merchants to undertake expenditures to protect against data breaches that provide merchants no protection whatsoever from punitive fees and fines if such a breach happens through no fault of the merchant.  And much more.  All of this is a vestige of an archaic payment system, dominated by Visa and Mastercard, which rests on outdated 20th century technology and rules geared to that technological rubric.

Against that backdrop (and recognizing that new technology is often the best way to inject competition in a non-competitive market), can new technologies break Visa’s and Mastercard’s dominance, and if so, might that technology prove to be blockchain?  The emerging consensus in the industry, at least with respect to blockchain, is probably not.  According to this view, because of its reliance on super nodes or miners to validate transactions, blockchain cannot scale to match Visa’s purported ability to process up to 65,000 transactions per second.  Skeptics also contend that blockchain’s decentralization is inherently unsuited to retail payments because, in consumer-to-business contexts, rules are necessary to address disputed transactions, among a host of thorny issues.  For these and other reasons, the conception is that blockchain is better suited for business-to-business payments or cross-border transactions.  While that may be true in the near term, does that tell the whole story?

Put simply, it does not.  A mere glance at the Big 3 payment networks’ “career” pages reveal a much more interesting and nuanced picture. Blockchain specialists, software engineers and code writers, data scientists, cloud infrastructure developers, and information security specialists are being hired by the hundreds.  At the same time, blockchain content and offers are beginning to appear on network and bank webpages and social media.  So, what are the banks and networks up to?

Visa, MasterCard, and American Express have been developing unique blockchain-based solutions for some time. This could reflect the fact that, while slow throughput undermines the viability of blockchain for payments per se, the technology could have substantial benefits with respect to recording, auditing and retrieving transactions.  Those benefits could reduce fraud and chargebacks, two of the material problems with our current payments system.  Perhaps motivated by those incentives, Mastercard, most significantly, has filed an array of patents.  Among them, Mastercard proposes a new method for linking assets between blockchain-based and fiat currencies, and even a patent for a multi-currency blockchain system that is partitioned to scale and ease the process of block generation.  Most notably, Mastercard is developing a system to combat identify theft by securely storing users’ payment credentials on a blockchain.

Visa has taken a more targeted approach and will be rolling out its long-awaited business-to-business blockchain platform called Visa B2B Connect this quarter.  B2B Connect will be managed by Visa’s standard practices and uses enterprise blockchain infrastructure to quickly and securely process B2B payments globally. The platform will consist of a method to automate the transfer of digital assets through the network without any third-party involvement. The entire process also will be transparent through the use of unique identifiers.  For compliance purposes, users will be screened before they can fully use the services on the platform.

Not to be left behind, American Express has also developed its own B2B product.  But even more interesting for the future of retail payments, American Express also has developed a blockchain-based membership rewards program that will provide its merchants a trove of SKU data on purchases to tie rewards to products merchants want to move off the shelf.  When a consumer makes a purchase, the blockchain stores all associated-transaction details and exports them to a dashboard.  On the backend, each merchant will operate on an individualized-smart contract which is conditioned to pass the transactional information directly to American Express through a secure-private channel. The merchant can use this data to identify potential offers based on what, when, where, and how customers are purchasing. This will finally allow merchants to provide individualized reward offers in real-time. It will also offer American Express a deeper level of transparency to track how and where points were rewarded.  What is unclear, however, is how American Express will be getting access to SKU data and whether merchants will have the ability to control whether or not they participate in this program.  That hugely important question for merchants aside, the notion that blockchain could be operationalized to provide targeted and relevant offers in a closed loop environment is intriguing.

As for Visa/Mastercard banks, they also are studying new ways to leverage this technology. Last month, Chase debuted its first mainstream blockchain product which relies on its own cryptocurrency, JPM Coin. The system will initially be used to speed up B2B settlements for its corporate clients but will be expanded to execute securities transactions and treasury services.  Other major banks, including PNC and Santander have been testing various blockchain-based payment systems including Ripple’s RippleNet and the Stellar-based IBM World Wire.

While most of these developments involve B2B and cross-border applications, they hint at broader applications for blockchain in retail payments.  American Express’s platform, based on its ability as a closed loop network to link merchants to its issuing infrastructure, could prove groundbreaking, and if it does, we might see more banks deploying blockchain approaches to working directly with merchants.  Yet that will only happen if Visa’s and Mastercard’s rules enable issuing and merchant partnerships outside of the traditional interchange system, where merchants might be willing to share SKU data to benefit their customers and engender more loyalty.  Since there is no indication yet of such rules changes, we continue to view Visa’s and Mastercard’s forays into blockchain with suspicion.  This wouldn’t be the first example of dominant players coopting potentially revolutionary technology to preserve their market power.  Whether that is happening merits ongoing scrutiny.