Lessons for Blockchain from the history of Credit Card Adoption

TL;DR version:

Blockchain offers a vision for the future where individuals regain financial autonomy. The most clear vision of this future is the use of tokens for financial transactions. Blockchain tokens, or cryptocurrency as they are known to the masses, provide new value to individuals from banking the unbanked to the creation of new industries. This value, though powerful, will face an uphill challenge to be unlocked via technological development and gaining a critical mass.

The adoption of tokens today shares many parallels to credit card adoption in the 1950s. This article provides a historical account of credit card adoption and suggests that history offers valuable insights into what it will take to bring tokens mainstream. To gain mainstream adoption, credit cards faced numerous challenges including fierce competition, a lack of infrastructure, fraud and security vulnerability, an uneducated user base, and lack of regulations. Yet despite early doubt and scorn by users and merchants alike, today 3 in 4 American adults have a credit card.


Hurdles to Mainstream Adoption

Today, blockchain tokens promise the next wave of innovation in financial transactions. Yet doubters and naysayers only seem to focus on the many challenges blockchain currently faces.

So I asked myself: What will it take to bring tokens mainstream?

The answer comes in four parts:

  1. Unique value creation for merchants and consumers
  2. Ease of use for businesses’ end users
  3. Scalability to become a legitimate option for large businesses
  4. Finally, history tells us regulation comes with mainstream adoption, not before

Each of these requirements are necessary for universal mainstream adoption. Businesses that look to blockchain need it to do more than raise funds or build hype: it needs to offer unique value over existing alternatives. User design of blockchain tools needs to be improved so that end-users don’t have to deal with the hassle of writing down lengthy private keys on pieces of paper. And finally, businesses that facilitate millions of transactions a day can’t afford to employ a technology that is limited to hundreds of thousands of daily transactions. Scaling blockchain transactions to handle large networks is a prerogative for the mainstream adoption we are talking about.

The story of another financial transaction system offers a fascinating comparison to the requirements above: credit cards.

Credits Cards worked through providing new value to consumers and merchants in spite of initial limitations and competition with existing programs. Once the value of credit cards started to emerge, banks had to spend significantly to encourage user adoption. When use began to grow, banks built large complex networks to handle the rapid growth of transactions. The adoption of tokens won’t happen exactly as the adoption of its older sibling, but an examination of the history of cards provides a surprising amount of similarities and lessons for the way ahead.

The History of Credit Cards

How did we get to the point where credit card payments could be verified in seconds?

The complex infrastructure enabling card payments came from humble beginnings. In 1950, Frank McNamara founded the Diners Club with Ralph Sneider. Legend has it that McNamara came up with the idea for a credit card upon realizing he had forgotten his wallet while out to dinner. He imagined a charge card that could be used at multiple eating establishments, offering the ability to sign at the time of purchase and pay later.

Before the Diners Club card, many merchants allowed customers to keep open tabs that they would pay back later. To do this, merchants kept track of customer purchases in ledger books, which could grow to hundreds of accounts and required each customer’s records to be aggregated and tallied. The ledger book system was a time intensive and frustrating process. Imagine if the next time you bought shoelaces from Amazon, an employee had to go to the vault of customer records to add that $.99 to your list of purchases.

To make life easier, businesses gave customers tokens and later “charga-plates” to identify them. But this meant customers had to carry around multiple metal charga-plates, one for every store they frequented.

A 1950 Charga-plate courtesy of the The National Museum of American History

A single card for multiple restaurants and hotels had obvious appeal and before the year 1950 ended, the Diners Club had 20,000 users in New York. Initially, memberships sold for $5 and 27 restaurants participated.

As Diners Club expanded, it allowed customers to borrow credit from a middleman and pay that middleman back later. Diners Club charged a 7% fee on purchases and an annual fee. Despite high fees, users were drawn to the card that became a status symbol for those who could afford its novelty and convenience.

Banks took notice and saw growing opportunity. Companies like American Express and Bank of America soon followed suit issuing cards of their own, and the race for dominance of the credit card market began. That race took a turn in 1958 when Bank of America introduced a general-purpose credit card that could be used anywhere as opposed to the cards prevalent at the time, which were limited to dining, travel, and entertainment. Although a few general-purpose cards had been offered before, none were backed by a company with the resources of Bank of America.

The card offered a $500 active credit limit and revolving credit so that customers could pay down balances over time, as opposed to in full at the end of the month, a radical innovation at the time. Bank of America introduced this “Bank Americard” in what is now known as the Fresno Drop. The pilot program was an expensive gamble, 60,000 of these cards were mailed to Bank of America customers in Fresno, California. Though the experiment lost money for the first three years, over time it blossomed into a lucrative and widespread institution.

Today, Bank of America notes that this pilot program was a huge success, omitting the fact that the mass mailing resulted in widespread fraud and delinquencies. People would steal cards from mailboxes on days they were delivered and 1 in 4 customers didn’t pay back the loans costing the bank millions. In addition to the fraud, merchants resisted accepting the card and the fees that came with it.

In spite of merchant resistance, expensive investment, and widespread fraud, the Bank Americard became a huge success, revolutionizing the way in which consumers and merchants interact.

Eventually licensing agreements with banks outside of California produced the network that became Visa while Visa’s competitors merged to create Mastercard.

Where cards are today

Credit cards today are easy to use. Paying for things you can’t afford is a national pastime and card payments occur in the blink of an eye. Curiously, while all three of these pieces are fundamental of mainstream technologies skeptics almost always focus on scalability.

The importance of the speed at which a transaction can be processed should be self-evident.

Anyone who has ever paid for groceries with a Visa credit card and waited for the payment to be approved can picture this process: for a second you smile at the cashier.

During that short human interaction, your card data is read and a request is sent to a third-party merchant to facilitate the appropriate payment channel. In the case of a credit or debit card, an acquirer, a financial institution, processes the request on behalf of a merchant. The acquirer sends the request to Visa who in turn sends the request to your card issuer. Your card issuer checks that your card is in good standing and, if your card isn’t frozen and there are sufficient funds in your account, respond to Visa with approval. Visa passes this information onto the acquirer and finally, the acquirer passes it onto the grocery store.

The second passes; you thank the cashier, take your groceries and leave.

This complex sequence of interactions occurs every time anyone uses a credit card. Visa and other payment networks facilitate thousands of these transactions per second, enabling merchants around the world to process millions of payments instantly. If the process wasn’t fast it wouldn’t work; shoppers would not wait for hours for the transaction to be processed. With blockchain, more transactions can clog the network meaning that with more users the slower the process for funds to transfer.

With any technology that attempts to solve a complex problem, progress will come iteratively. The evolution of today’s payment processing for credit and debit cards offers a prescient guide of what is to come for mainstream blockchain adoption. The story of credit card adoption does not begin with scalability, but with providing merchants and customers value. Only later after demonstrating their value, did credit cards see widespread adoption.

Unibul’s money blog provides the infographic and a great article on this in more detail.

What Blockchain Can Learn from Credit Card Evolution & Adoption: 6 Takeaways

The long road to mainstream adoption of credit cards offers valuable lessons for the future of blockchain and digital currencies.

1) Working products come first

The first credit card wasn’t technically a credit card at all. The Diners Club card was actually a charge card since balances had to be paid when the monthly statement was issued. Credit as a concept took time to be worked into the system, and it came iteratively with periods before repayment growing longer. Credit cards were at first a niche product used by a select group of businessmen in NY. FICO scores, general acceptance, and a host of features to make credit cards more appealing came as the market adapted.

The lesson here is simple. Blockchain adoption will start with projects that have working use cases even if those cases aren’t glamorous. Growth will take time, but that’s healthy. Adoption is a marathon, not a sprint.

2) Adoption follows value

The Diners Club card solved the problem of carrying around cash or a bag full of charga-plates. While limited at first, the Diners Club card aimed to offer convenience to both consumers and merchants. General purpose credit cards enabled consumers to consolidate their finances. In spite of the fees, merchants no longer had to manage their own accounts and gained consumers who wouldn’t have used their store otherwise.

Blockchain needs to scale before businesses will adopt it, but it also needs to offer value to merchants and consumers. Consumers today have payment options that work fairly well, so gaining adoption requires adding value.

3) Security and regulation take time and the best companies lead the way

Bank of America convinced users to try their Bank Americard by offering credit cards mailed with an active line of credit. Havoc ensued with thieves and users trying to game the system. It took a full TEN YEARS before the government stepped in to regulate credit card lenders. The Truth in Lending Act of 1968 made it illegal to mail active credit cards to people who hadn’t asked for one, effectively prohibiting the promotion program Bank of America had used to encourage adoption.

In the meantime, Bank of America had to learn how to protect itself and users and created Collection and Fraud Departments to track down bad actors. For cryptocurrency to go mainstream blockchain companies need to set out to fix security issues, not wait for regulators to take action. The companies that will be successful in the space will be focused on protecting users and stopping bad actors.

4) Businesses want relationships with their customers

Strong emotional attachments to stores and brands keep customers coming back. When Credit Cards emerged, they relieved customers of the need to have accounts at stores if they didn’t have cash on hand. While the credit card opened the door to new shoppers it also saw some shoppers become less loyal. No account? No problem! The same item on sale at a rival? No problem!

We are seeing businesses of all kinds trying to rebuild relationships with customers. From Starbucks to Amazon, companies try to build loyalty with reward programs for continued use.

At OST we see Blockchain enabling businesses to engage their customers in more dynamic ways. Token loyalty programs powered by blockchain offer significant advantages over traditional loyalty programs in the forms of ownership and interoperability for consumers and token rules and financial accounting treatment for businesses.

5) Disruption creates more value than incremental improvements

While credit cards were invented to make life more convenient, the real benefit was the creation of value in the form of liquidity. Millions of users could now purchase on credit to the tune of hundreds of dollars. The implications were massive, consumers could purchase big items they wouldn’t have dreamed about purchasing before. People could improve their standard of living by buying expensive items like refrigerators and televisions on credit and pay them off over time. Businesses also benefited by selling more units and opening up consumer segments that were previously priced out.

The true power of new technology is the value that it adds to an economy and individuals standard of living. Incremental improvements add little in the way of value, disruption can add huge amounts of value in the form of industries or monetizing things that previously weren’t. The real value of tokens are not incremental improvements to existing processes, but the creation of new liquidity and earning streams to improve people’s quality of life. At OST we are designing token economies that create value for consumers and help our business partners attract and retain loyal customers.

Just imagine consumers earning tokens by supporting their favorite platforms and using those tokens to pay their rent or buy school books. Check out some amazing concepts here.

6) Technology improvements come with tradeoffs

While cards are fast, they are far from perfect, requiring multiple third parties transacting with one another. This means lots of fees and points of failure. These problems highlight opportunities for blockchain to improve the system, but importantly they also shed light on the future of the technology. The many parties and steps that support card payments took time to develop, and are hidden far away from any card users’ day-to-day experience. Solutions to problems evolve over time and many when first proposed are not seen as solutions at all.

Credit cards are now a 50-year-old technology, but updates are still controversial today. Take the latest credit card example of a solution that came with a trade off, the chip reader. Introduced to replace magstripes and make credit payments more secure EMV bank card technology came with tradeoffs that proved frustrating for both merchants and customers. Chip readers are a few seconds slower processing transactions than the swipe method, leading to annoyance and longer lines when it was rolled out. The chip reader was an additional cost too, one that many small businesses felt. EMV compliance rules went into effect in 2015 and 3 years after there is still user resistance.

This is something we experience all the time in the blockchain industry. The technology here is so new that updates and decisions on how to move forward with blockchain technology have developed their lore. If you spend enough time talking blockchain you’ll hear about the survivors of the DAO hack or complaints about some fork from a rival solution. What the industry needs most is practical solutions that will help bring on board merchants and mainstream users. That’s why we are developing OST KIT turnkey solutions for mainstream businesses and OpenST and OpenST Mosaic, a protocol for scaling applications on Ethereum. Mosaic is designed to help businesses deploy their own tokens and run them at the speed of real business. We don’t know what the future looks like, but we do know the needs of the present and at OST we are building blockchain solutions that meet those needs.


Credits and Sources

Thanks to the many contributors who offered valuable input into this article including Jack Kuveke and the OST team, especially David Brill.

References:

Berg, Nate. “The Fresno Drop”, Episode 196, 99 Percent Invisible, https://99percentinvisible.org/episode/the-fresno-drop/

Schmalbruch, Sarah. “The credit card was invented by a man who forgot his wallet at dinner”, 2 March 2015,<https://www.businessinsider.com/history-of-credit-cards-2015-2?IR=T>

Tsosie, Claire. “The History of the Credit Card”, 9 Feb 2017,<https://www.nerdwallet.com/blog/credit-cards/history-credit-card/>

“Charga-Plate in Red Leather Case, United States, 1950’s.” National Museum of American,History,<http://americanhistory.si.edu/collections/search/object/nmah_1251614http://americanhistory.si.edu/collections/search/object/nmah_1251614>

“Introducing the Modern Credit Card”, Bank of America, <https://about.bankofamerica.com/en-us/our-story/birth-of-modern-credit-card.html#fbid=bH6WBgu1qUB>


About the Author

Paul Kuveke is Blockchain Strategy Consultant for OST. He works with OST’s North America Partners to think through applications of OST KIT and design blockchain solutions to meet their business needs.


About OST

OST blockchain infrastructure empowers new economies for mainstream businesses and emerging DApps. OST leads development of the OpenST Protocol, a framework for tokenizing businesses and the OpenST Mosaic Protocol for running meta-blockchains to scale Ethereum applications to billions of users. OST KIT is a full-stack suite of turnkey developer tools, APIs and SDKs for managing blockchain economies. OST partners reach more than 300 million end-users. OST has offices in Berlin, New York, Hong Kong, and Pune. OST is backed by leading institutional equity investors including Tencent, Greycroft, Vectr Ventures and 500 Startups.