Money Over Time

The banks and credit card companies have spent 50 years building a proprietary, locked-down system that handles roughly $2 trillion in credit card transactions and another $1.3 trillion in debit card transactions every year. Until recently, vendors had little choice but to participate in this system, even though — like a medieval toll road — it is long and bumpy and full of intermediaries eager to take their cut. Take the common swipe.

When a retailer initiates a transaction, the store’s point-of-sale system provider — the company that leases out the industrial-gray card reader to the merchant for a monthly fee — registers the sale price and passes the information on to the store’s bank. The bank records its fee and passes on the purchase information to the credit card company. The credit card company then takes its share, authorizes all the previous fees, and sends the information to the buyer’s bank, which routes the remaining balance back to the store. All in all, it takes between 24 and 72 hours for the vendor to get any money, and along the way up to 3.5 percent of the sale has been siphoned away.

In the earliest days of credit cards, those fees paid for an important service. Until the late 1950s, each card was usually tied to a single bank or merchant, limiting its usefulness and resulting in a walletload of unique cards. But when BankAmericard — later renamed Visa — offered to split its fees with other banks, those banks began to offer Visa cards to their customers, and merchants began accepting Visa as a way to drive sales. Meanwhile, Visa and rival MasterCard — as well as distant competitors American Express and Discover — used their share of the fees to build their own global technological infrastructures, pipes that connected all the various banks and businesses to ensure speedy data transmission. For its time, it was a technologically impressive system that, for a price, brought ease and convenience to millions of buyers and sellers.

Money Over Time
A brief history of
currency technology.
—Bryan Gardiner
1200 BC: Shells

Rare or exotic items like shells, whale teeth, and metals were used for trade by cultures around the world because their scarcity and beauty lent them great symbolic value. (The earliest Chinese character for money was even a cowry shell.)

But today, vendors are seeing fewer benefits from paying those fees, even as credit card companies have jacked them up over the years. Credit cards were once a way for a business to differentiate itself from competitors, but now that they’ve grown ubiquitous, nearly all vendors must accept them or risk losing a huge swath of customers. According to a 2003 study in the Review of Network Economics, every sale by credit card costs a merchant six times what the same sale with cash would run. (Cash comes with its own costs, such as requiring more oversight of cashiers, upkeep of vaults, and a bank’s services to process it.)

Not that the store owner is ever quite sure how much a credit card transaction will cost. MasterCard and Visa charge hundreds of different rates — called interchange fees — for every type of card that runs through their networks; mileage cards tend to charge higher fees, for example. And if a retailer accepts one flavor of Visa, say, it has to accept them all, no matter the fee. In 1991, MasterCard had four fees, the highest of which had an interchange rate of 2.08 percent. Today it has 243 fees, and the heftiest one tops out at over 3 percent — more than a 50 percent jump. And yet the service provided has hardly grown any better, faster, or easier to access. “It seems really odd that credit card companies can continue to charge a tax on the economy,” says Aaron Patzer, founder of the financial management service Mint.com, which is now owned by Intuit. “Outside the US government, they are the only entity that has the power to levy a fee across virtually every transaction. Maybe that made sense in the early 1960s, when computer infrastructure was expensive and proprietary. But now, with cheap bits everywhere, the actual cost to do a transaction is pennies.”

There is, in other words, a massive inefficiency to be exploited. And so, an army of engineers and entrepreneurs is rushing in, hoping to do to the payment world what has already been done to the music, movie, and publishing businesses — unseat a legacy industry built on access and distribution, drive the costs to zero, undercut the traditional middlemen, and unleash a wave of innovation. Square’s Dorsey sees his company as creating a new, open system that allows users to swap funds instantly, without a series of interlopers grabbing their share. “We bring an engineering discipline to this problem,” he says. “What we want to know is, how can we get right to the source?”