Picture of a Credit Card Transaction

The following is the simplest infographic I could find of how a credit card transaction works from UniBul’s Money Blog. If  you go to the page their are actually a couple of other infographics on credit card transactions.

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Here is the prose version:

Betty swipes her card and her account number, the expiration date, the billing address’s zip code, and the CVV code is sent to something called a front-end processor (in the above example Authorization Step 2 it is shown as Master Card but this is most often farmed out to a private company). The front-end processor’s job is to quickly check that Betty’s card has enough funds to cover the payment. It forwards the information contained on her card to a network of the relevant card association (MasterCard, Visa, American Express, etc.) that figures out the issuing bank the card came from. Her transaction now moves to a separate payment processor representing the issuing bank, the one whose name is on Betty’s card and manages her account. Once her bank has verified the validity of the information and checked for sufficient credit, a signal goes back the other way. The bank tells its processor to give the all clear to the association, that conveys it back to the front-end processor so that Farmer John and the acquiring bank can be satisfied that Betty has enough funds to cover the oranges. Within seconds Farmer John is notified of the approval.

Betty is walking away with her oranges. However, the payment system is not done. Farmer John has not been paid for delivering the oranges. For that to occur Farmer John must send a follow-up request to his acquiring bank, usually in a batch of receipts at day’s end. The acquiring bank will pay Farmer John for those receipts, but it will need to place a request for reimbursement from the issuing bank, using an automatic clearinghouse (ACH) network managed by either the regional Federal Reserve banks or the Electronic Payments Network of the Clearing House Payments Company, a company owned by eighteen of the world’s biggest commercial banks. Still, Betty’s bank won’t release the funds if it’s not convinced that it was really she who bought the oranges. So before it even gets the request for payment, its antifraud team has been hard at work analyzing the initial transaction, looking for red flags and patterns of behavior outside her ordinary activity. If the team is not sure about who was swiping the card, it will call Betty’s cell and home phone numbers, text her, and e-mail her, trying to get her to confirm that it really was her at the Farmers Market. Once her bank is satisfied that all is aboveboard, it will release the ACH settlement payment and register a debit on her credit card account. The money then flows to Farmer John’s acquiring bank, which credits Farmer John’s account. This process typically takes up to three business days to complete.

All this processing is not done for free. Each entity in bold red letters takes a cut of Betty’s transaction which usually totals between 1 and 3 percent of the sale. This may not seem like a lot but when you take into account all sales world wide…

 

Picture of Blockchain Transaction

I have been reading “The Age of Cryptocurrancy” by Paul Yigma and Michael J. Casey. They provide this simple to understand image of how a blockchain operates.

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A Practical Example of Farmer John selling Betty some oranges for $1.50

Betty goes to the Saturday morning farmers market in her town and wants to purchase $1.50 worth of oranges from Farmer John. Betty will use a cryptocurrency for this transaction (Bitcoin). Farmer John presents Betty his payment address as a quick response code:

Bill's address

Betty uses a Bitcoin wallet on her smartphone to scan the code. She is presented a screen where she can enter an amount to send to John’s address. She types ‘$1.50’ and presses send. A moment later John’s tablet notifies him that there is an incoming payment pending, which is not confirmed yet. About ten minutes later, the payment is finalized when it gets confirmed.

Why 10 minutes? Will be left for another discussion.

Under the hood

1) The Payment Transaction:
The software on Betty’s smartphone checks whether she has a sufficient balance and then creates a payment transaction. This transaction is composed of three pieces of information: Which “coins” to spend, the recipient, and a signature.

Betty’s wallet is connected to other participants in the network. The wallet passes the transaction to all of them, who in turn pass it on to all of their connections. Within a few seconds, every participant in the network has received notification of Betty’s payment order. Each and every participant checks whether the listed “coins” exist, and whether Betty is the rightful owner.

2) Confirmation:
So far, Betty’s payment is only a promise, because it is still unconfirmed.

To change that, some network participants, which we’ll call miners, work on confirming these transactions. The miners grab all the unconfirmed transactions and try to pack them into a set. When their set doesn’t fit the requirements, they reshuffle it and try again. At some point, somebody finds a set with the right properties: A valid block.

Just as with the transactions before, they send this block to all their connections, who in turn forward it to theirs. Everyone checks the work (to confirm that the block follows the rules) and when satisfied, they apply the included transactions to their own ledger: The transactions get executed and the “coins” that were used by Betty get transferred to Farmer John as ordered by the transactions. Betty’s transaction (and all the others) is now confirmed. Betty can now eat her oranges and Farmer John can now spend his “coins”.

Miners are compensated for processing transaction through the issuance of newly minted cryptocurrency coins by the blockchain. Neither Betty nor Farmer John incur any cost for this transaction.

Blockchain

Blockchain

Blockchain

I have been aware of blockchain technology since 2010 when I came across an article on the subject, however, I was slow to realize the extent of the possibilities of the technology until mid-2015 when I started reading up on the topic.

At its core blockchain is relatively easy to understand. The blockchain is a public ledger where transactions are recorded and confirmed anonymously. It’s a record of events that is shared between many parties. More importantly, once information is entered, it cannot be altered. So the blockchain is a public record of transactions.

The blockchain was initially created to track the transactions (purchase/selling) of cryptocurrancies but it can be used for much more. Here are some examples:

Ownership Trading – The technology can be used to track any type of digital asset be that tickets, merchandise (digital down load of software, music), products, subscriptions among many others. See Peertracks

File Storage – Peer to Peer file sharing networks removes the need for centralized databases and heavy storage areas. IPFS (Planetary File System) – an innovative protocol is complimenting this big change. See  Storj

Voting, Authorization, and Authentication. An increasing number of organizations and political parties have proposed the creation of a blockchain-based system to build a fairer and more transparent voting environment. See Factom

The list of projects is endless. See below for some applications in FinTech:

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