February 05, 2012

Why did VISA pull the plug and leave the "little people" high and dry?

Clive asks in comments a long time ago (apologies for late reply):

any thoughts to VISA's extraodinarily abrupt behaviour over stopping all ePassport issued VISA cards?

( http://m.krebsonsecurity.com/2010/09/visa-blocks-epassporte/ )

Aside from the seamier side (which all financial systems attract) a large number of "little" people used the system to be paid for their legitimate labours (code cutting etc) and VISA appears to have left them high and dry.

Hi Clive,
One comment gives a fairly good impression about what to expect. I'd say this is a fairly typical pattern in alternative payment systems.

Aside from that, let me develop it in a series of viewpoints.

Evolution. It goes more or less this way: Some entrepreneur figures out a way to get a hot money product out there that appears to bypass the conventional channels. This is reasonable, economic, and politically appealing.

(By politically appealing, we might recall that quote about Paypal founders telling all their new staff about the end of government, libertarians to rule the world, boundless new efficiencies, etc.)

For a while, whichever payment system we are talking about, it does well.

A new product that provides a completely new way of doing business will always find a market in those that really need that. This will also include a significant proportion of morally questionable activities, being those that are shut out by conventional channels which have decided to impose the morals. So, both "clean" and "morally questioned" users exist, both, and both of them are contributing their revenues to the wellbeing of the new payment system. (Cases in point are: video, ecommerce websites, cheap telephony, certificates.)

The latter group, which we might call the moral arbitrageurs, have an advantage because their business model generally promises higher margins. They tend to grow faster, and frequently become the major force at many levels in new business models.

Attack. At some point, the arbitrageurs in the system start to do too well, and come to the attention of some authority somewhere. It matters not which one, or which product, or which morals. That authority starts investigating, figures out where the weak parts are, and leans on them. In the case of payment systems, the weak points are generally the finance partners.

Once the leaning starts, the partner pulls out. In the case identified the partner is Visa, but more often it is a partner bank. This brings us up to the point where Clive asks, but why!? Why did the partner pull out and leave the "little people" high and dry?

For the partner, it is a question of straight economics, not morals. Let's look at the economics of the payment partner. It is based on fees, many of them, easily collected, without trouble, because margins are tight. Each of those fees that is then reneged upon, or worse, the principal is lost, results in much higher costs to the facilitator. So each partner can only accept a tiny percentage of failures before it starts losing money.

Hence, an attacker (in this case the authorities) only needs to lean on a small percentage of payments before the entire body of payments is seen as a loss by the facilitator.

There doesn't need to be a proof of a crime, or indeed any evidence. Just the knowledge by the bank that it isn't worth the fees anymore is good enough, as any fee benefit is going to be consumed in compliance overload and risks. Also, the bank (Visa) knows that a lot of the traffic that is shut out of this system will find its way back to the "legit" system one way or another, and therefore, the bank often prefers to see the alternative payment system as competition it would rather destroy, rather than honest trade to be defended.

In the alternative payments market, it doesn't need much pressure to get a partner to walk away.

Enemies. Where it goes wrong, or what is wrong with this entrepreneurial process depends on who you ask (and yes I'm getting to your second question :) If you ask the regulators, these systems are made for money laundering (ML), so shut them down, or else. No discussion possible, there, because the claim of ML always sticks like mud. If we ask the banks, they'll say they are unfair competition, as the newcomers don't have to pay the regulatory toll (which the incumbents argued successfully for), and the nasty cheap competitors are too cheap. Shut 'em down, yesterday, already! No interest in negotiation.

On the plus side, if we ask the operators, they will say that the system is fair, adults are entitled to play adult games, and real competition is what consumers deserve. They might also point to their safeguards. Nobody ever asks the consumers, and there is little benefit in asking the suppliers of whichever questioned goods we are offended by :)

All these things are likely true at some level (and false at other levels), so which is which and which are correct or false or relevant or specious tends to be irrelevant, because they can all be used. And often are. The alternative payment system lives in a very aggressive world, they have too many enemies.

Addiction. But, I have a different perspective. If you ask me, I'd say it is because the operators got a little too addicted to the morally questionable business. They should have been smarter, avoided the addiction, and eased themselves off it before the habit turned nasty.

Where, both how much and which drug are defined by their circumstances. As I'm most familiar with the story of gold payment systems, a decade or so back, let me outline that one by way of example, but please also note that the evidence published by Paypal reveals the same forces.

The gold community's morally questionable friends were the ponzi schemes and fast-moving payments games, which on the strength of fees income, took the e-gold business into the black, early 2000. This was around 9 months after the first games (aka ponzis) turned up above the radar, so quite a stunning result. I'd also mention that e-gold wasn't the only one, there were others on all sides of the tracks, but e-gold was the leading indicator, the case study.

At that point (strategically speaking, says I), as they entered the black, they should have shifted strategy to increase other "cleaner" opportunities, and reduced the impact of the arbitrage games/schemes. Instead, it could be said that they seemed to chose to defend the adults in their right to participate in these things. Two things are worth noting. This is the libertarian view, which is quite popular in arbitrage sectors, so e-gold's customers were happy. Secondly, adults do have a right, at some fundamental level to lose all their money. But they also seem to like going crying to regulators after enjoying their right to unregulated carnage. And crybabies punch above libertarians at about 100:1 (take note Ron Paul).

Hence, the pattern is somewhat inevitable. For the gold sector, the steamroller started moving by end of 2002, and within 5-6 years, a lot of players were shut down.

Now, with that in context, your real question was this: why did all these honest people lose their money? Why so sudden? Why so immediate?

I think the answer to that is found in the world views of the players. The Feds/banks have already decided that (a) the system is illegal, or quasi-illegal, and, the people using it are either (i) outright crims, (ii) engaging in immoral or quasi-illegal behaviour, or (iii) should have known better than to associate... Further, it will be an internalised truth for the investigators and the banks that, if there are any honest people, they will come forward and prove a claim to the money. "If you've done nothing wrong, you have nothing to hide."

Some of this is true. There were criminals using those gold payment systems, and it was bad stuff. I don't tend to write about it because (a) I lack strong evidence, and (b) people simply don't believe it when I tell them. "Yadda, more conspiracy talk..." It was bad stuff.

That said, it is also true that not all users are tarred with the same brush. The crims are a minority. Many of the users are honest, and they will still lose. Big time. Here's why, on the demand side:

  • Not all will those honest people will come forward (because they are scared),
  • not all people will be able to prove their claims (because the case is already stacked against them),
  • some of them will have questionable behaviour of other forms, and worry about collateral damage,
  • many of the holdings will be in the order of under $10k and therefore uneconomic to fight, and
  • many of the people concerned will not have enough money to pay for legal help (especially those that lost a lot of their money!).

Of course there will be some claims, and some money paid out. On the supply side, the Agency has the incentive to give it a go, because it keeps the money.

So, to answer your question, it's because of a combination of forces:

  • the bank could not care less, and it would like the competition to go away anyway;
  • the odds are stacked against the people claiming the money back; and
  • the value seizure is done by people who are structured to ignore the issue, because they are going to benefit.

And, to restate my view: the operators took the good times to heart, and didn't clean up their house quickly enough to escape the backlash.

Again, apologies for the long & late reply.

Posted by iang at February 5, 2012 05:24 AM | TrackBack

for something similar ... but different, for your archives:

Mythbusters Banned From Discussing RFID By Visa And Mastercard

Posted by: Lynn Wheeler at February 5, 2012 01:21 PM
Post a comment

Remember personal info?

Hit preview to see your comment as it would be displayed.