Electronic Payment Systems 20-763
Electronic Payment Systems 20-763
Electronic Payment Systems 20-763
20-763
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Course Objectives
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Course Outline
• Introduction to Money and Banks
• Automated Clearing and Settlement systems
• ePayment Security (cryptography, digital certificates)
• Credit Card Protocols: SSL/TLS and SET
• Stored-value Cards
• Micropayments
• Electronic Cash
• Electronic Banking
• Electronic Invoice Presentment and Payment (EIPP)
• Future of epayments
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
How Much Payment Is There?
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Electronic Payment Systems
20-763
Lecture 1
Introduction to Money
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Lecture Outline
• Nature of money
• What is a payment?
• What is a payment system?
• Desirable properties of money
• Payment system requirements
• Payment risks
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
The Payment Process
NATIONAL ECONOMY / FINANCIAL MARKETS
CUSTOMER PAYMENT SERVICE SYSTEM
BANKING SYSTEM
INTERBANK SYSTEM
Buyer Seller
Payment Payment
Access Access
Buyer Point Bank Clearing House Central Bank Bank Point Seller
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Development of Money
• Definition: “something generally accepted as a medium of
exchange, a measure of value, or a means of payment.”
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Barter
• Direct exchange of goods and services -- possible
when production exceeds individual needs
• Problem: “double coincidence of wants”
– Trade a bicycle for a cow
– Alice must have a bicycle and want a cow
UNLIKELY
– Bob must have a cow and want a bicycle
• But: Internet allows rapid discovery of wants
• Problem: remote barter requires an escrow (or risk)
• Problem: outside the monetary and tax systems
• When money is not trusted, barter returns
• Electronic barter systems exist, e.g. LETS
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Types of Money:
Fiduciary vs. Scriptural
• Fiduciary money (fiat money, legal tender)
– Issued by a central (government) bank
– Has real “discharging power” (to discharge debts)
– Cannot be refused
• Scriptural money (not legal tender)
– Money not issued by a central bank
– Examples: bank accounts, travelers checks, gift certificates,
scrips
– Discharging power based on trust in issuer
– Can be refused
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Types of Money:
Token vs. Notational
• Token money
– Represented by a physical article (e.g. cash)
– Can be lost
• Notational money
– Examples: bank accounts, frequent flyer miles
– Electronic (scriptural) money: wide recognition
– Jeton = electronic token with limited recognition
• Hybrid money
– Check
– Telephone card (carries jetons for future service)
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
The Money Matrix
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Specialized Payment Instruments
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Bill of Lading (B/L) Transaction
1. BUYER SENDS SIGHT DRAFT TO SELLER
BUYER SELLER
2. SELLER DELIVERS
8. BUYER PRESENTS GOODS AND SIGHT
B/L, CLAIMS GOODS DRAFT TO SHIPPER
6. SELLER’S BANK
7. BUYER’S BANK CREDITS SELLER’S
4. SHIPPER SHIPS ACCOUNT, NOTIFIES
DEBITS BUYER’S SHIPPER’S SHIPPER
ACCOUNT, GIVES SELLER
DOCK
B/L TO BUYER
3. SHIPPER CREATES
B/L, SENDS IT WITH
DRAFT TO BUYER’S
BANK
BUYER’S SELLER’S
BANK BANK
5. BUYER’S BANK PAYS
DRAFT TO SELLER’S BANK
SHIPPER IS AN ESCROW AGENT. IF B/L IS NOT PRESENTED, GOODS WILL NOT BE DELIVERED
IF SELLER NEVER SHIPS GOODS, SHIPPER WILL NOT GENERATE B/L AND BUYER’S BANK WILL NOT PAY
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Ecommerce Payment Ranges
Minimum Typical Maximum
Transaction Transaction Transaction
Value Value Value
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Objective of Payment Systems
• To allow the payee to obtain real (fiduciary) money
– Usually in his bank account (convertible to fiduciary)
– Cash is rare except for low-value face-to-face payments
– Consider a credit card. Who pays the merchant real money?
• Payment in real money is called settlement
• Most payments are not settled individually
– Example: bank checks – too small to justify separate
transfers of funds; they are batched for efficiency
• Batching to determine how much real money must be
paid is called clearance or clearing
• Payment systems must provide for both clearance
and settlement
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Credit Card Transaction
1. BUYER TENDERS CREDIT CARD INFO TO SELLER
BUYER SELLER
6. SELLER SHIPS GOODS TO BUYER
2. SELLER TRANSMITS
8. BUYER’S BANK PAYMENT DATA TO
SENDS BILL TO 5. SELLER’S BANK
9. BUYER PAYS SELLER’S BANK
BUYER CREDITS
BUYER’S BANK
SELLER’S ACCOUNT,
USING SOME
NOTIFIES SELLER
OTHER METHOD
OF PAYMENT
3. SELLER’S BANK
ASKS BUYER’S BANK
FOR AUTHORIZATION
BUYER’S SELLER’S
BANK BANK
4. BUYER’S BANK
AUTHORIZES/REJECTS
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Payment Issues
• How does the payor know how much to pay?
(bill presentment, invoicing)
• What mechanism will be used to “pay” (payment)?
• When will payment be made (before, during, after)
• How will the payments be added up? (clearance)?
• How will the payee receive real money (settlement)?
• How will the payee credit the payor (reconciliation)?
• What records are available to the parties (audit)?
• Security for all the above
– authentication of parties
– prevention of forgery
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Payment Systems by Timing
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Some “Payment” Methods
• Cash
• Check
• Credit transfer (giro), automated clearinghouse (ACH)
• Interbank transfer (EFT)
• Credit cards
• Payment cards, smart cards (Mondex, phone cards)
• Aggregation (accumulation, e.g. Qpass)
• Intermediaries (PayPal)
• Scrip systems (micropayments, e.g. Millicent)
• Loyalty systems (Flooze, Beenz -- now bankrupt)
• Electronic cash
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
System Issues
• Physical support (smart card, files, encrypted strings)
• Value representation (denominations, numbers)
• Location of value store (bank, electronic wallet)
• Discharging power (who accepts it?)
• Mode of use (remote, face-to-face)
• Methods of payment (credit transfer, jeton exchange)
• Genuineness (is it valid? stolen? double-spent?)
• Authentication (of user)
• Traceability (anonymity, privacy)
• Scalability, cost
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Desired Properties of Money
• Universal acceptance
• Transferability, portability
• Safety (unforgeable, unstealable)
• Privacy (no one except parties know the amount)
• Anonymity (no one can identify the payor)
• Work off-line (no need for on-line verification)
• Divisible into change (pay for $10 item with $100 bill)
• Arbitrary denominations (e.g. $325.14)
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Costs of Money
• Time
• Risk
• Physical cost (print currency, mint coins)
• System infrastructure
• Processing cost (transactions)
• Security
• Human time
• Law enforcement
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Payment Risks
• ALL RISK HAS COST
– Suffering loss has cost
– Protecting against loss has cost
• System design must respond to risk posture
(willingness to accept various kinds of risk)
• Transferable v. non-transferable risk
– Insurance
– Hedging
• Example tradeoff: open v. closed payment networks
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Payment Risks
System design must respond to risk posture
• Operational (reliability and integrity)
– Security (unauthorized access)
– Employee fraud
– Counterfeiting (ecash)
– System design, implementation, maintenance
– Customer misuse
– Service provider risk
– System obsolescence
– Transaction repudiation by customer
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Payment Risks
• Reputational
– Negative public opinion loss of business
• Bank of New York Russian money laundering
• Lose both legitimate customers AND launderers
– System deficiencies
– Security breach
– Failure of similar systems
• Systemic
– Risk that failure to meet an obligation spreads
through the system, causing others to fail to meet
obligations
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Payment Risks
• Legal
– Violation of law, ambiguity, legal sanctions
– Money laundering
– Inadequate disclosure
– Violation of privacy
– Violation by linked site
– Certificate authority risk
– Foreign law
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Payment Risks
• Banking
– Credit (non-payment, insolvency)
– Liquidity (demand for redemption of ecash)
– Interest rate (spread)
– Market (inflation, foreign exchange)
– Cross-border (social, political, economic)
• Crime
– Fraud, forgery
– Theft
– Kiting (illegal use of float)
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
B2B Payments
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
B2B Payments
Buyer Supplier
Order
• Procurement • Order Mgmt
• Receipt Status Order Confirmation • Fulfillment
• Reconciliation • Credit and
and Payment Advance Shipping Notice Collections
• Financing/ • Financing/
Cash Mgmt Invoice
Cash Mgmt
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Major Ideas
• Money classifications
– Token v. notational (what form does it take?)
– Fiduciary v. scriptural (“real” (government) or issuer-based)
– Prepay, instant-pay, post-pay
• Risk is a factor in all payment processes
• Cash is very expensive to use
• B2B payments are complex
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS
Q&A
20-763 ELECTRONIC PAYMENT SYSTEMS FALL 2002 COPYRIGHT © 2002 MICHAEL I. SHAMOS