When Apple Pay launched, the term "tokenization" became an industry buzzword, even if many didn't really understand how it works. Now blockchain, is causing even more head scratching. But will regulatory compliance and security issues thwart this payment medium?
"With tokenization, consumers are not aware of how a transaction will take place, but rather that it will take place when they need to make a purchase," said Vice President of Financial at the Minneapolis — based Entrust Datacard Ray Wizbowski.
"Tokenization in mobile payments has injected life into this implementation with the establishment of several token service providers, which make the mobile payment transaction secure by issuing a one-time or limited-use token which maps back to the account holders account," he added.
Wizbowski explained that blockchain or "distributed ledger" is different because it is quickly linked to cryptocurrencies such as Bitcoin. While there are more than 20 cryptocurrencies worldwide, Bitcoin, released in 2009, was the first decentralized ledger currency.
The Bitcoin movement, however, took a hit in June. New York federal prosecutors discovered a fraudulent Bitcoin scheme run through a bogus company's account at Helping Other People Excel (HOPE) Federal Credit Union, a $291,000 institution based in Jackson, N.J. The alleged charges include operating an unlicensed internet Bitcoin exchange as a way to launder money for a criminal network. Indictments on two men are pending.
"This technology anonymizes the transaction, making the sender and receiver untraceable, and has been perceived as the currency of criminals," said Wizbowski. "Due to this perception, this technology, although very secure, will have a more difficult time making its way into mainstream banking."
John McAlister of Dorado Industries, a global payments consultancy firm, said it is important to separate Bitcoin, which is a value from blockchain, which is a process. "From a value standpoint, they are inexplicably linked because you can't have Bitcoin without blockchain, but you can have blockchain without Bitcoin."
New Currencies, Old Regulations
Supported by American Express, Visa and MasterCard, the advantages of tokenization include the removal of the physical credit card from the transaction, which can decrease fraud. As such, token-based mobile transactions, also supported by countless merchants, have grown over the last year.
While blockchain is viewed as secure, CO-OP Financial Services Business Manager of Product Development Ryan Zilker said regulations are not keeping step with technological advancements. In short, payment mediums like Bitcoin will likely stay on the CU sidelines for the foreseeable future.
"Security is a piece of the concern and then there is regulatory uncertainty," said Zilker. "Regulators are looking at Bitcoin, but there hasn't been any decisions made. In this industry, Bitcoin is like an undiscovered country and I don't think credit unions want to be the first to test it out."
From McAlister's stance, Bitcoin doesn't represent an investment grade asset for credit unions. "It's too volatile and not a guaranteed value or asset — risky at best," he said.
Conversely, he said blockchain has value because its algorithm is an alternative way to account for ownership. For example, financial institutions can extend credit and if the credit isn't accepted the financial institution can take it back. The same process can be used for money transfers. He adds that blockchain could be a beneficial accounting tool integrated with existing systems.
"From a credit union perspective, I don't see Bitcoin as something to augment financial returns, and I don't think there is desire for it across the population," said McAlister. "However, determining how to use blockchain to improve internal access and liabilities and payments, I think there is something there." He added that any advancement in this direction would be many years down the line.
With tokenization Wizbowski noted that c-level executives will need to undertake a solid risk assessment of the TSP (token service provider) to ensure the data vault, which translates the tokenized PAN (primary account number) into the real PAN, is following industry best practices for layered security.
"In the case of blockchain, executives need to have a good understanding of the regulatory environment around an anonymized financial transaction. Many of the cryptocurrency online market places have been shut down for their high percentage of illegal activities funded by cryptocurrencies," said Wizbowski. "At this stage, with the focus on KYC (know your customer) and anti-money laundering laws, it seems very difficult for a financial institution to be able to fully embrace this type of financial instrument."
