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Tokenization could be the Trojan Horse that will break the credit card rails


Tokenization was all the rage at Money2020. It is one of those buzzwords that float around market spaces in a way that excludes outsiders. If you know what tokenization is, then you are a payments insider. If not, you get the look that says, “please find another conversation to join”.



Bernard Lunn
Bernard Lunn
One of our missions at Daily Fintech is to explain arcane insider jargon to make it accessible to a broader community. Most concepts are simple if explained well.

Tokenization is the one time password that a student of cold war espionage stories would recognize. If you steal the token/one time password, you can steal the contents of that message/payment and only that message. That is fundamentally different from stealing the Primary Account Number (PAN). If you steal the PAN (by physically stealing a card or reading the mag stripe encoded data from a merchant) you can steal a lot of money.

If you want to understand why Credit Card fees are so high, you only need to know one word – fraud. Combatting fraud is expensive. The ingenuity of fraudsters – given the amount of money at stake – is endless.

If you cut down fraud, you cut down costs. The Credit Card has a massive incentive to cut down fraud in online “card not present transactions” for the simple reason that the switchover to Chip based cards in America will move fraud to online transactions. That is what happened in Europe as we explained in this post in August (1). Tokenization will solve that problem, so that e-commerce does not take a hit.

"So tokenization is critical and will have to happen. It is not a maybe. You can count on tokenization happening."

The question is, how will this disrupt the credit card rails? With tokenization the consumer does not need a piece of plastic and is not worried that merchants will have their PAN (or credit card number as a consumer calls it). That is kept secure elsewhere. So why not enable transactions mobile wallet to mobile wallet (maybe using Bitcoin but actually any currency is OK) using the same tokenization concept. Technically this is quite simple.

"So far we have seen incremental innovation that builds on top of the credit card rails."

For example, Square (and then a host of imitators) enabled micro merchants (farmers markets etc) to take payment via their mobile phone. They are all fighting over the % of the fees that are not taken by the credit card networks. Tokenization may enable new players to take on those credit card networks directly.

Payments attracts entrepreneurs like bears to a honey pot because it is such as massive market. According to Boston Consulting Group (2):

“In 2013, payments businesses generated $425 billion in transaction revenues, $336 billion in account-related revenues, and $248 billion in net interest income and penalty fees related to credit cards. The total represented roughly one-quarter of all banking revenues globally. Banks handled $410 trillion in noncash transactions in 2013, more than five times the amount of global GDP.”

"Yet dreams of disrupting the credit card payment rails have been repeatedly dashed against the rocks of reality. Payments has been the boulevard of broken dreams."

Incremental innovation, such as Square, Stripe and Braintree/Paypal has been the smarter play, but as these ventures mature and go public we can see that merchants are simply getting Basis Point reductions by playing off one against the other. That sounds like a commodity race to the bottom. Are there entrepreneurs out there willing to enter the boulevard of broken dreams and take on the credit card networks directly? Or will one of the sustainers with scale such as Square, Stripe and Braintree/Paypal go through the window of opportunity opened up by tokenization?

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech.

(1) http://dailyfintech.com/2015/08/04/in-october-when-america-catches-up-to-europe-with-emv-e-commerce-will-take-a-hit/
(2) https://www.bcgperspectives.com/content/articles/financial_institutions_pricing_global_payments_2014_capturing_next_level_value/

Bernard Lunn
Founding Partner, Daily Fintech Advisers
www.dailyfintech.com

Bernard Lunn is a serial entrepreneur, senior executive, adviser and a strategic dealmaker. He worked in Fintech before it was called that with startups, growth stage and turnaround ventures (incl. Misys, Temenos, IMS, ITRS). He has lived and worked in America, India, UK & Switzerland and is adept at cross border deals.

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Mardi 17 Novembre 2015
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