What are the Advantages & Disadvantages of the Oligopolistic Payment Structure

 Jonathan M. Hazell

 

The world has an oligopoly in credit card payments.  An oligopoly is an economic market system in which only a few firms can and do compete. It could in fact be argued that the U.S. has a duopoly in Visa and MasterCard as they 82% of the nation's market share. An important distinction has to made in understanding the credit card industry. Visa and MasterCard are not credit card companies in definition. They are networks connecting member banks. It is why a Visa Card issued is from a particular bank. American Express, by contrast is actually a company that itself issues credit. This is an important contrast that must be understood to evaluate the strengths and weaknesses of the payment networks employed in the modern credit system.

This system can be defined as a "pull" system. A customer pulls a payment from their account in a bank, say Chase. It goes through the given system, like the Visa Network, to the merchant where the payment is being made. The bank is essentially lending the money, so no existing funds are being extracted. The merchant can add extra fees, to the price of the product, to absorb transactional costs. The advantage of this system for the merchant is they are guaranteed a payment from the bank. The customer also has the recourse of rescinding the payment if the goods or service is inadequate. Their bank can stop payment since the payment is being transacted as part of a Net Settlement System.

All of this works well provided the system is secure. The network security in these credit transaction systems have an array of protection measures. Neural networks, common protocols, shared data sources on problematic merchants, etc. keep the system in place.

The reliance upon credit cards is only growing, "Over the past decade, while global GDP has increased from roughly $37.6 trillion to $70 trillion, or at a 6.4% annual growth rate, Visa's and MasterCard's combined revenue has grown from $4.2 billion to $17.8 billion, or a 15.5% annual growth rate." (1)

The potential world market for the industry is practically unlimited, "according to MasterCard’s most recent annual report roughly 85% of worldwide transactions are conducted in cash." (2) Countries are switching to plastic currency. (3) The credit card system will become even more normalized with this move. People are becoming more accustomed to dealing with plastic and computerized transactions. This trend will diminish the current high use of cash throughout the world. The security protocols within the transaction network though will have to be maintained. The central banking system, which essentially issues all the credit cards to the masses, also has to be preserved. If these two elements get compromised then the entire system itself is in jeopardy. The shortcomings of the centralized financial system and transaction network allows alternative systems such as Bitcoin and its Blockchain, room to grow and expand. One potential breach here in the U.S. itself, is the rapid rise in Social Security number theft. Much of the centralized banking and processing system is predicated on validated Social Security numbers. Identity theft rises every year. Currently the merchants bear the cost of this problem passed on from issuer banks. This issue alone makes the use of an alternative system, such as the Blockchain, based on encrypted keys, opposed to actual identifying document numbers, a viable and potentially better long-term solution. Merchants should like this because of the lower transaction fees.

 The challenge to using the Block Chain system is where the Bitcoin is stored and traded. Current exchanges do not insure decentralization. Merchants have also not adopted the Bitcoin payment system wholesale to take payments directly. A third party processor, like Coinbase, therefore is needed to insure trust. This third party option just mimics the current credit card system, creating a probable oligopoly or duopoly in the Bitcoin payment processing world moving forward unless other options are found.

Bibliography:

(1) http://seekingalpha.com/article/1320071-the-credit-debit-card-industry-almost-perfect

(2) http://www.fastgraphs.com/fast_graphs_at-a-glance/2014-1-10-credit-card-fastgraphs

(3) http://www.mirror.co.uk/money/new-plastic-bank-note-unveiled-8101866

(4) http://www.usatoday.com/story/money/personalfinance/2013/04/14/identity-theft-growing/2082179/