A brief history of card networks

To understand the future of payments, you have to understand the past. How did we arrive at a world dominated by card networks? How did Visa become the 11th most valuable company in the world, worth more than just about any bank globally? It has a 98% gross margin on $30B in revenue in 2023, and has grown payment volume 17.3% compounded annually for 51 years.

This is the story of Visa, but the learnings and journey are similar for all our modern payment methods from ACH to SWIFT to wires. 

The history of our payment rails starts with banks looking for a new revenue stream from their customers. They realized that making it easier to pay increased spend, and increased spend attracted consumers and merchants to the network. This in turn meant more money was moving across the network with every transfer via card. Banks went from earning money on deposits (money at rest) to earning money on movement (velocity of money). 

To unlock this immense value, banks had to build communication layers.

The drop

This story begins like all great web3 stories, with an airdrop. Arguably the most successful airdrop ever happened in 1958 when Bank of America (BofA) dropped 65,000 charge cards to its customers in Fresno, California. This single action kickstarted what eventually became Visa. 

Customers hadn’t asked for these cards; they didn’t even know such things existed. BofA thrust this new technology upon its customers because BofA needed a way to grow its business. At the time, it was illegal for banks to operate across state lines, so to grow as a consumer bank, it needed to do more of what it was already doing: taking deposits, making loans, and making money on those loans. In 1958 those loans were not only for homes and cars but also for appliances like washing machines and dishwashers. A customer would walk into a branch, ask for a loan, go to the store, buy the product and the bank would take the funds from your account each month. It was the original Buy Now, Pay Later but with a lot more friction.  

The network effect

Charge cards offered an opportunity for BofA to increase the number of loans it gave. In turn, and equally important, it allowed merchants to sell more. Customers wanted to use this new card because they could easily access credit, and merchants wanted to accept it because they could sell more. Incentives aligned. By solving the problem of reducing friction to getting credit, BofA kickstarted a new network with a strong flywheel.

As the icing on top, BofA banked most of the merchants and the customers in California, so when a customer used a card, there was actually no need to withdraw cash and deliver it to a merchant. The cash was going to end up back in BofA anyways when the merchant deposited it. Thus, cash was then able to sit on their balance sheet for longer, without any gaps, and continue to earn interest.

Growth

Of course, there was fraud - $20M of losses. But BofA kept at it, onboarding a whopping 2 million merchants in the first year (a number that took Dinner Club years to get to). They took a bet on this new innovation, and by 1961, three years into their endeavor, they got fraud under control enough that the whole program was profitable. 

At first, they didn’t tell anyone because they didn’t want to attract competition. But they had grand ambitions to live up to their name - Bank of America, so they had to find a way to expand outside of California, and to do this, they needed partner banks across the country. 

But what worked for a single bank that was the largest player in a single region did not translate. Chaos ensued. 

BofA made a bad assumption and missed a key feature that meant their network didn’t scale. They wrongly assumed their direct competitors - other banks - were willing to be controlled by them via this network. When it was just BofA, it was basically a closed-loop network. They were the biggest bank in California, so most of the time all parties in the transaction were their customers. When they expanded the network and let other banks in, all of a sudden, that was almost never the case. When a customer swiped a card, the customer’s bank needed to talk to the merchant’s bank and the infrastructure BofA had built simply did not scale (credit to Matt Brown for the diagrams).

For this network to grow, it needed a communication layer, one that was fast, resilient, and provided a standard to communicate across banks. And critically, they needed a neutral 3rd party to operate it so that any bank would be comfortable participating. 

In essence, they needed a network to streamline and solve the operational overhead that was required to settle those transactions. They needed a clearing house, a telecommunications network, data centers, card readers, just to name a few components. They needed what we now know today as Visa.

Visa, the killer technology company 

Visa is synonymous with finance, but it is really a technology company. They built a tremendously powerful infrastructure layer that spans 10,000+ banks across the globe that basically never goes down. All before there was even the internet. 

All this infrastructure is what is known today as interchange, and interchange fees are Visa’s lifeblood. Visa is a messaging system between banks, owned by banks. It had to be a company outside of these banks because they competed and didn’t want to be subservient to any one bank. And Visa thrived because it solved a workflow problem - it created a standard for communicating and transmitting payment information. Solving the workflow meant they earned the right for that payment to move across their network. 

The more cardholders and merchants the card network has, the more valuable it is. Every transaction that traverses the network pays a toll and that toll provides some value to each of the stakeholders. This in turn, creates a virtuous cycle where the network is used more and more, and new participants are encouraged to onboard. It’s an incredible business model with strong stakeholder alignment all around.

1. The customer that swipes her card gets easily accessible cash, credit, and reward points. 

2. The customer’s bank that issued the card (the issuing bank) gets a fee for onboarding this customer, thus encouraging them to onboard more and more customers that will swipe. 

3. The network gets a fee for remitting the transaction. 

4. The merchant gets to make a frictionless sale, expanding its revenue but paying a fee. 

5. The merchant’s bank (the merchant acquirer) gets a fee for onboarding this merchant to the network, thus encouraging them to onboard more and more merchants that will accept the card and pay this fee.

The banks realized and capitalized on the fact that the biggest, strongest network was an open-loop network between them all, and the best way to cooperate and encourage the network’s growth was through a neutral third party that ran it and enforced standards. Hence, we have the founding of Visa in 1976, which subsequently became Visa Inc. in 2007 and is now one of the most valuable companies and recognized brands in the world. 

Conclusion 

Payments is a story of incentives and networks. Remove friction and build the right incentive structures for all parties, and you win the right to process payments across a broader and broader network of participants. These networks require a communication layer to function, and that’s what Visa unlocked. 

If you want to learn the whole story of Visa, I recommend the Acquired podcast on Visa.