The Anatomy of A Card Network

You tap, you swipe, you enter your pin, what happens next? Let’s unpack the blackbox of money movement, starting with card networks - our most frequently used tool in North America.

For a lot of consumers understanding how a transaction works is a question that they’ve never really asked, or really had the need to understand. But understanding how money is moved around both regionally and globally is an important fundamental in determining where opportunities for innovation or improvements are available. There are lots of ways to move money but let’s start with one of the most common ways to perform a transaction today in North America; Debit and Credit cards.

Debit and Credit cards fundamentally run on the exact same technology infrastructure in the United States and most of the world for that matter. If you are using a card to pay for something, there is a good chance one of Visa or Mastercard is going to be responsible for enabling that transaction. As consumers we take for granted the layers of technology that exist to facilitate a payment but at least from a high level, it’s not as hard to understand. For this discussion we’ll look at who is involved in a transaction, the lifecycle of a transaction, and how a transaction is secured.

What’s important to think about while reading this is where new companies and technologies have inserted themselves to improve or augment this process. For example, Stripe changed how online businesses process card payments, Chime and Nubank changed how consumers access card services, Lithic and Unit enabled fintechs to build card products.

Let’s starts by discussing who is involved in the process. The Key Players are:

 1. The Customer: That's you – the individual holding the card.

 2. The Merchant: The business that's ready to accept your card for their goods or services.

 3. The Acquiring Bank: The merchant's financial partner, which takes the transaction details and forwards them to the card network. Prior to being able to accept payments a merchant must have a relationship with an acquiring bank.

 4. Payment Processor and Gateway. Those merchants that don’t have an acquiring bank, such as those that use Square or Shopify, will utilize the services of a gateway. In this case its those companies that have an acquiring bank relationship and likely use a payment processor such as Stripe to facilitate the transaction. In this relationship a gateway takes in the transaction information and the processor sends it to the issuing bank. These can be combined or separate companies that offer this service.

 5. The Issuing Bank: Your financial institution, which provided you the card and decides whether your transaction gets approved or declined. This is fundamentally your current bank.

 6. The Card Network: The facilitator of the process, acting as the intermediary between the acquiring and issuing banks. Big players here include Visa, MasterCard, American Express, and Discover. This is the most important infrastructure in payments as these companies basically form the interconnected web between banks.

So now we know who is involved, how does a transaction get facilitated. The Transaction Process is as follows: 

1. Authorization: When you make a purchase, the merchant sends the transaction details to the acquiring bank (if they are using a point of sale device) or a payment gateway (typically for online payments), which then forwards them to the card network via the processor. The card network then sends them to the issuing bank for approval.

2. Authorization: The issuing bank checks if you've got enough money for the purchase. If everything checks out, it sends an approval code back down the line to the merchant.

3. Clearing and Settlement: At the end of the day the acquiring and issuing banks exchange agreed upon balance differences. Essentially banks look at all the cash they are owed by all other banks and what they owe to those banks as well. They then net it out the difference and pay out the delta of amounts or request it from each other. In the United States, the Federal Reserve plays a crucial role in this process, as it facilitates the transfer of funds between these banks through its settlement systems, such as the Fedwire Funds Service and the Automated Clearing House (ACH) Network. Each country has their own settlement process but typically it will run through a central bank or similar type of Authority. This ensures that the acquiring bank receives the funds from the issuing banks, and the merchant ultimately gets paid for the transactions. This is also the reason why some transactions don’t show up right away on your account because this process occurs in batches.

Credit Card Networks vs Debit Card Networks

While credit and debit card networks involve similar players and processes, there's a key difference. Credit card transactions use the cardholder's line of credit from the issuing bank, while debit card transactions directly withdraw funds from the cardholder's bank account. This means that debit card transactions require real-time authorization from the issuing bank to confirm sufficient funds, adding a layer of complexity to the process. However because this check is done, even if the settlement and clearing process hasn’t completed yet, the transactions will be considered as good as cleared even if the banks haven’t settled yet. This is why you can typically see debit card transactions right away but credit card payments can take a couple hours or even a few days to show up on your account.

With credit card purchases, the card provider (i.e Visa) can keep track of the balances available since they facilitate the movement of the transaction information related to that line of credit. This means they don’t always need to check the issuing bank for available credit - they can poll the bank periodically for balance availability. Balance discrepancies can sometimes occur if a customer has transferred money off a credit card through non network activities (like cash advances from a branch or through online money movement in the bank customers account). The same thing doesn’t occur with debit cards since the authorization of available funds happens in real time, checking the actual balance.

 Securing the Transaction

Security is the one of the most important aspects of every financial transaction and it’s a blend of proactive and reactive technologies. Asides from encryption, Some of the innovations we’ve seen are digital card tokenization and chip and pin cards.

However, Fraud is still one the most important and challenging attacks to prevent against. Card Networks, Payment Processors, and Gateways all try employee various fraud detection techniques and services. These can be developed in house or provided by third party companies like, sardine.ai which analyzes transactions at time of processing for possible fraud. These techniques can be checking lists of known fraudulent cards or looking at location and transaction patterns. For example, if a transaction occurs outside your country or if you are making 10 purchases faster than a normal human would be able to, or just things you don’t commonly buy.

Fraud detection is always a battle between speed and assuredness. The lifecycle of an entire transaction is around 1-2 seconds, and everything described above needs to happen in that time period. Visa and Mastercard set strict response time limits on their networks and technology developers building ontop of these networks could be penalized for slow performance and lose access to the networks.

New techologies can both unlock new security threats but also enable new fraud detection solutions. This is why the best security is often blocking a transaction before it can even start. Companies like DataDome offer browser and device fingerprinting techniques to identify profiles of fraudulent actors before they can even initiate the transaction. For companies that offer Buy Now Pay Later services, there can also be steps involved to identify the payor and use their transaction histories available through their bank to understand their shopping behaviours.

Comparing Visa, MasterCard, and American Express.

Visa, MasterCard, and American Express are three of the largest credit card networks. They form the backbone of the consumer payments infrastructure in most of the world. Even Regions like Latin America, South East Asia, and India which have large consumer economies that function without cards – are seeing increasing card network penetration from these three providers - though Amex less so. So its important to understand the scale of these companies and what they do, because if you are offering card services, one of these three is likely involved.

1. Visa: As of 2020, Visa processed over 141 billion transactions worldwide, with a total payment volume of $8.8 trillion. Visa is known for its wide acceptance and extensive global reach, making it a popular choice for consumers and merchants alike.

 2. MasterCard: In 2020, MasterCard processed around 108 billion transactions globally, with a total payment volume of $6.3 trillion. MasterCard is also widely accepted and offers various benefits and rewards programs for cardholders.

 3. American Express: American Express, often referred to as Amex, is known for its premium services and rewards programs. In 2020, Amex processed approximately 9.2 billion transactions, with a total payment volume of $1.2 trillion. While not as widely accepted as Visa and MasterCard, Amex is popular among affluent consumers and businesses.

For individuals who don’t really interact with card payments technologies, they may assume all the revenue comes from interest on card balances. However that’s not entirely true, another substantial chunk of that revenue comes from interchange fee’s - this is the card network collecting a fee that is typically a percentage of the transaction for use of their services. For example Visa may collect 0.5%-1% of a transaction, and other service provides will layer their own take ontop of that - Stripe typically charges 2.9% + 30cents a transaction and the reason is because they pay a lot of the 2.9% to various other service providers in the lifecycle . This is why merchants typically don’t like credit card payments because its the merchant the bears the cost of the interchange fee, whereas debit is typically a flat charge of 0.25 cents to $1. The unit economics of card transaction is another topic all together but a lot of the money for card service providers is made by inserting themselves into the interchange fee stack.

In Closing.

The credit card networks play one of the most vital global roles in authorizing consumer payments. However, their job is just to form the connectivity between major institutions and the individuals’ exchanging goods and services. This has created a lot of opportunity in the last decade for new companies to build on top of these rails. Even legislation in Europe (SEPA and PSD2) enabled opportunities for new fintechs to further evolve payment networks.

Which leads into a the next topic of discussion. Card networks represent only one way to move money around globally. There are still many other topics to discuss; ACH, FedNow, Interac, Apple Pay, Wire Transfers, Swyft, UPI, Digital Wallets, Account to Account Payments, etc. Moving money is a complex consideration of speed, cost, and security, where Cards are just the tip of the iceberg. Look out for future releases on more of these technologies.