Quick Thoughts – Visa, the Blockchain, and Ledger-Technology Innovation

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Howard Mason

203.901.1635

hmason@ssrllc.com

November 30, 2015

Quick Thoughts – Visa, the Blockchain, and Ledger-Technology Innovation

Visa faces several structural threats: distributed ledger technologies, such as the block-chain, are not one of them. The reason is that the efficiency of interbank settlement is driven by regulation, not technology, and that is not going to change while money is, by definition, an obligation either of the federal government or of participant-banks in a fractional-reserve system. If consumers and institutions want to use IP-enabled settlement technology to exchange the modern-day equivalent of cowry shells (i.e. units-of-account on a distributed ledger), that is fine but swapping the associated currency for US money ultimately and always involves the Federal Reserve.

That is not to diminish the possible commercial applications of block-chain technology. Distributed ledgers have significant potential as a B2B transactional network including in correspondent banking, for intercompany and intracompany (“private” block-chain) transfers, and to link existing electronic payment networks (including ACH in the US with SEPA in Europe). Chris Larsen, CEO of distributed-ledger vendor Ripple, articulates this network-of-networks opportunity as follows: “We are trying to solve the problem of connecting local banks and financial institutions to the global economy where we have a variety of different networks [which], whether they are in the US or Kenya or Europe, are not connected. You can make a phone call to anyone with a phone number and you can send an email to anyone with an email address, but you can only pay people that are in your payment network.”

However, we do not see distributed ledgers as providing a direct-to-consumer service if only because of the KYC and AML requirements of money-transmitters (which include distributed-ledger providers given guidance[1] from the Financial Crimes Enforcement Network or FinCEN, responsible for regulating money-transmitters, that decentralized convertible virtual currencies, such as bitcoin, will be treated in the same way as money) and the fact that failure of a ledger-provider to register and file the money-transmitter reports required by the Bank Secrecy Act (BSA) is a criminal offence[2]. Indeed, given Visa is a consumer brand it is more likely to be a beneficiary of the block-chain, used as a back-end processing network, than a victim; already the firm has invested[3], alongside C and Nasdaq, in the ledger startup chain.com and indicated an interest in using distributed ledger technologies to extend its franchise from payments (i.e. the settlement of money transactions) to the settlement of “smart” assets (i.e. assets whose ownership is represented by a digital asset on a distributed ledger).

This brings us to the structural threats that Visa actually faces which are to do with challenges to its brand. Visa operates a vertically-integrated model in that it controls an acceptance brand (represented by the Visa signs displayed at point-of-sale by merchants) as well as a transactional network providing authorization, clearance, and settlement (ACS) services. This vertically-integrated model has generated extraordinary economics through rent-seeking, as opposed to profit-seeking, behavior (i.e. involving not the creation of wealth but its transfer from one party to another – in Visa’s case from merchants to banks via interchange and thence to bank customers via rewards): specifically, Visa argues to merchants that if they want access to the buying power of consumers using the Visa transaction network, they must embrace the Visa acceptance brand at a very high cost.

However, the vertical integration of acceptance brand and back-end processing is breaking down as consumer adoption of smartphones fundamentally changes the economics of the payments business so that the key adjacency becomes not the bank checking-account but the merchant loyalty-account. The result is that the Visa brand is being increasingly wrapped whether by Apple, Google, and Samsung (Apple, Android, and Samsung Pay respectively), by banks (with ChaseNet being the early example but clearXchange likely to generalize at least, given Durbin, to debit), or by merchants (with SBUX being the early example but CurrentC, from the retailer payments consortium MCX likely to generalize). It does not matter that in each of these mobile presentment plays, Visa may provide the processing necessary for transaction fulfilment. What matters is that a third-party has displaced Visa as the acceptance brand and, having branded the consumer payments experience, erodes Visa pricing power and is in a position to activate, if not build, alternative ACS “rails”.

©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. The analyst principally responsible for the preparation of this research or a member of the analyst’s household holds a long equity position in the following stocks: JPM, BAC, WFC, and GS.

  1. https://www.fincen.gov/statutes_regs/guidance/html/FIN-2013-G001.html
  2. http://www.coindesk.com/bitcoin-law-what-us-businesses-need-to-know/
  3. http://www.forbes.com/sites/laurashin/2015/09/09/visa-citi-nasdaq-invest-30-million-in-blockchain-startup-chain-com/
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