It's holiday season, and it only makes sense that one of the hottest selling items at Starbucks is the PSL. But what really happens when you pay for that coffee with your credit card? On surface, it's a transaction wherein you are 'charged' the $4.37 and Starbucks gets that $4.37 in their account. All of this in a matter of seconds. How does this happen? In this multi part series, I plan to explain various parts of the payments ecosystem and various areas where there has been rapid innovation.

Over the last seventy years, the key players in a credit (or debit) card transaction have remained the same:

  1. To make credit card payments, you will need a credit card issued by a bank. This card can come in various forms:
    a. A physical card made of plastic, which may have a magnetic stripe at the top and/or a chip.
    b. A virtual card, which is just a card number displayed in an app and can be used for online transactions.
    c. A tokenized card, which is stored in a digital wallet like Apple Pay or Google Pay and can be used to make payments by tapping your phone on a compatible reader.

Issuer - An issuer, also known as an issuing bank, is a financial institution that provides customers with a bank account, a debit card, and potentially access to credit facilities and a credit card. Examples of issuers include Citibank, Wells Fargo, Bank of America, and Chase.

Issuer Processor - An issuer processor is a technology provider that connects to the payment networks on behalf of the issuer. This allows the issuer to approve or decline transactions. An issuer processor may have a piece of hardware in their data centers and a fast network connection directly to the payment networks to facilitate this process. An issuer may have built this technology in-house or may rely on a third-party issuer processor, such as Marqeta, Tsys, i2c, Adyen, and Galileo.

  1. To accept credit card payments, merchants need a machine that can read the card. This machine is known by several names, including a card reader, card terminal, payment terminal, or point-of-sale (POS) system. For merchants with a physical location, this machine is typically used to process credit card transactions in person.

For online merchants, a payment gateway is used to process credit card payments. This is not a physical machine, but rather a piece of software that handles the transaction.

Merchant Acquirer - A merchant acquirer is a financial institution that acquires merchants and provides them with the tools and facilities to accept and process card-based payments. Examples of merchant acquirers include Citibank, Wells Fargo, Bank of America, and Chase.

Acquirer Processor - A merchant acquirer needs a technology provider that can connect with payment networks on their behalf. This provider is known as an acquirer processor. An acquirer processor typically has a piece of hardware in their data centers and a fast network connection directly to the payment networks, which allows them to request approval of a transaction. A merchant acquirer may have built this technology in-house or may rely on a third-party acquirer processor, such as Chase Paymentech, Tabapay, or Fiserv.

  1. The payment network, also known as a card scheme or network, sits between acquirers and issuers and facilitates the exchange of information needed to complete a credit card transaction. Payment networks include Visa, Mastercard, American Express, and Discover. These networks provide the infrastructure for card-based transactions to occur and set the communications rules and standards that acquirers and issuers must follow.
  2. To ensure the security of these transmissions, a stable Internet connection is necessary. This can be achieved through an Ethernet connection or Wi-Fi. In the past, dial-up connections over phone lines were used for this purpose.

Let's look at an example. Rob drives up his favorite burger joint and orders a burger and fries to go. At the checkout, he taps the card on the payment terminal. When the tap happens, there is a quck beep and Authorizing appears on the payment terminal.

The payment terminal sends a message to the Acquirer Processor with information about the transaction, including the amount, location, merchant type, and card number. The Acquirer Processor determines that the card is a Visa and routes the transaction to the Visa Network. Visa then uses the first six digits of the card, known as the Bank Identification Number (BIN), to identify the issuing bank, which in this case is BuzzBank.

Visa sends a message to BuzzBank with information about the transaction, including the card number, amount, location, and merchant type. BuzzBank's Issuer Processor then reviews this data and decides whether to approve the transaction. It will consider several factors based on the information provided by Visa, such as:

  1. The cardholder's credit history and available credit limit
  2. The merchant's history and reputation
  3. The location of the transaction (to check for fraud)
  4. The transaction amount (to check for unusual or suspicious activity)
  5. The cardholder's spending patterns (to check for unusual or suspicious activity)

Note that these are just some examples of the types of factors that an issuer processor may consider. The specific factors that are used can vary depending on the issuer and the specific transaction.

If everything looks okay, the transaction appears as Pending on Rob's statement (note: this typically does not include tips which Rob may have added to the check - more on this later).

Visa will then relay this information from the Issuer to the Acquirer. The Acquirer Processor will then send the message to the payment terminal to approve the transaction. It ends up with an Approved message on the terminal. Rob may be asked to sign the receipt for a variety of reasons:

  1. To verify that Rob is the person who made the purchase: By signing the receipt, you are confirming that Rob is the person who made the purchase and authorized the use of the credit card.
  2. To provide proof of purchase: The signed receipt can serve as proof that Rob made a purchase on a particular date and for a specific amount.
  3. To deter fraud: Requiring a signature can help prevent unauthorized charges from being made on Rob's credit card.
  4. For the merchant's record-keeping: The signed receipt is a record of the transaction that the merchant can use for their own record-keeping and accounting purposes.

Overview of the four-party model

In a card payment transaction, there are four key players: the merchant, the cardholder, the issuing bank, and the acquiring bank. These four parties make up the "four-party model."

  • The merchant is a company that sells goods or services and wants to accept payments from customers.
  • The cardholder is the customer attempting to make a purchase from the merchant. This can be an individual or a business.
  • The issuing bank is the bank that issues the card to the cardholder. The issuing bank is responsible for approving or denying transactions, providing credit, and collecting the balance at the end of the month.
  • The acquiring bank is the merchant's bank partner that processes payments on their behalf and is a licensed member of the card networks. The acquiring bank connects to the card networks and is responsible for four key aspects of payments: authorization, clearing, settlement, and reversals (refunds and chargebacks).

In addition to these four parties, there is a fifth player known as the networks (Visa, Mastercard, American Express). The networks provide the infrastructure and rules for how the parties interact and also aggregate funds so that not every issuer has to communicate with every acquirer.