NOTES ON THE INFOBAHN: Finding the Right Mechanism For Internet Sales

The Internet today may be facilitating worldwide sales of anywhere between $10 million and $100 million annually. Given the current growth rates and popularity surrounding this new, boundless distribution channel, sales over the Internet could grow dramatically, moving as much as a half trillion dollars annually in goods and services internationally by the year 200.

Banks have more than a vested interest in understanding how sales take place now on the Internet and how they are likely to be consummated in the future. Providing authentication and settlement services in cyberspace represents a whole new market for banks' payment system franchise.

The challenge for facilitating payment over the Internet is determining which mechanisms Wt with the electronic medium and take full advantage of its capabilities to facilitate trade - while providing necessary security and integrity of settlement. Internet payment alternatives can be grouped in four categories: Las Vegas type systems, systems based on electronic mail, encryption-based systems, and cryptocash- based systems.

The key components behind any of these systems are: when payment is initiated, when settlement occurs, and how authentication and validation of accounts occur.

In Las Vegas type systems, buyers are requested to enter credit card numbers without any security mechanisms. Many examples of this can be seen on the Internet's World Wide Web. Numerous home pages allow buyers to consummate purchases by entering their credit card numbers on-line. The Internet transports data through multiple junction points for any given transaction, sometimes five, sometimes 50 or more.

A transaction could leave a digital shadow at each switching along the line. Each of these computers could harbor the potential for criminal activity.

The beauty of the payment system based on electronic mail is that it avoids the risk of passing bank card, checking, or debit account numbers over the Internet.

First Virtual Holdings Inc. is among the first safe payment systems up and running today on the Internet. The company has developed a unique, simple, convenient, and low-cost Internet payment system that provides a Wnancial transaction link to the banking system.

Here's how it works. Both merchants and consumers establish accounts with First Virtual. Consumers select the payment method and accounts from which they will settle transactions, initially limited to MasterCard and Visa cards. The account numbers supplied by consumers are obtained over touch-tone telephone calls and never pass over the Internet. The bank card and checking account numbers remain on a very secure non-Internet computer system.

With merchant and consumer accounts established, consumers initiate purchases over the Internet. Merchants inform First Virtual of charge requests initiated by consumers. Consumers are then sent an electronic mail conWrmation request from First Virtual that requires a response.

The First Virtual Internet Payment System process provides safe transactions without the need for Internet users to purchase or install additional software or equipment. It relies entirely on the most popular and easy-to-use part of the Internet: electronic mail.

Electronic mail, or some derivative thereof, could be the launching pad for many other new forms of electronic payments. However, the development and promotion of these payment schemes are likely to be initiated by nonbanks - which historically have been less dependent on paper and plastic.

The banking industry is especially keen on seeing encryption-based systems become the de facto payment standard on the Internet. Why? Because they allow banks to leverage the existing brand awareness and name recognition associated with the current payment methods, namely checks and credit and debit cards.

Encryption-based systems scramble consumers' existing bank and credit card account numbers as they are entered on-line for real-time purchases. Using this method of payment is not much diVerent than supplying your credit card number to an operator for a telephone-based purchase - except you are expected to enter the number yourself and have access to a hardware device or software that will encrypt your account number as it is entered.

Here's what the major players in this arena are doing:

l An alliance between Microsoft and Visa International will let Windows users make secure credit card purchases over the Internet.

l Netscape Communications Corp., which produces an advanced graphical navigator for the Internet is teaming with credit-card processor First Data Corp. and MasterCard to support credit card purchases on the Internet.

l Cybercash Inc. is working with several banks to offer a secured connection for authenticating credit and debit card transactions over the Internet.

l Open Market is offering a complete electronic infrastructure for establishing and managing a business on the Internet.

l Terisa Systems, a joint venture between Enterprise Integration Technologies and RSA Data Security, is planning a line of secure Mosaic products for commercial transactions.

l Netcheque, developed at the Information Sciences Institute of the University of Southern California, allows users to write electronic checks to other users and deposit them as well.

If successful, these firms will enable the banks to maintain their control of the payment system and provide the timing flexibility to allow consumers to use credit cards to delay payment or debit-based accounts for immediate payment.

The opportunities go far beyond payment, however. Encrypted transaction transportation and processing will allow banks to tap into some of the unused computer capacity of their customers' PCs. The strategy is similar to that of automated teller machines, which, essentially, turn customers into employees by having them complete the mundane, repetitive teller transactions themselves.

Point of presence processing engines such as personal finance software packages and PC-based accounting systems could do the preprocessing and ship the completed transaction to the bank's data base.

How? Consider having a loan application icon added to the menu bar of, say, Intuit's Quicken. The loan application could be completed by the borrower and the information entered could be compared to the encrypted standards for the ultimate lending agency.

The encrypted software program could determine the borrower's credit risk/rating. The borrower would be informed of the ranking by the program and directed to those lenders likely to accept the degree of risk determined by the program. The encrypted loan application can then be packaged and shipped to those potential lenders via the Internet.

The fourth category, cryptocash-based systems, provide the consumer with electronic cash, possibly with the same anonymity as provided by real currency.

Consumers must transfer electronic cash equivalents from their bank accounts to their electronic purse, be it their stored value or chip card, encrypted PC, or personal digital assistance software or hardware device. Cryptocash systems work like travelers checks, requiring consumers to fund the payment medium before they make the purchase. The electronic purse must be Wlled with cash in advance of the purchase, unlike the methods above where the consumer either consummates payment at the time of purchase or delays settlement for the purchase.

Encryption takes place on multiple levels in the cryptocash scheme: on one level at the bank, another at the chip card or software, and another in the actual value exchange over the electronic network. Companies working to bring this payment mechanism to reality include Digicash, Visa, MasterCard, and Mondex, a consortium led by two British banks.

The advent of digital money and its market acceptance presents a substantial opportunity for expansion of the payment system by banks and nonbanks, depending on who is the first to set the architectural standard and capture a meaningful following for their electronic cash equivalent. l

Richard K. Crone is a senior manager in KPMG Peat Marwick's financial services consulting practice in Los Angeles. Mr. Crone can be reached by electronic mail via the Internet at: RCrone.KPMG.com

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