Background on Digital Payments

In this chapter, we provide an overview of the predecessors of Bitcoin and their associated crypto-based payment schemes. In particular, we define the notions of payment security and privacy as established in already existing payment systems. Next, we provide an overview of alternatives to banking-based payment technologies that preceded Bitcoin, with a particular focus on their security, privacy provisions, and implementation deficiencies (if any).

More specifically, in Sections 2.1 and 2.2, we present a generic payment model, detailing its architecture and security and privacy requirements. In Section 2.3, we list a number of desirable properties of payment systems and their impact on security and performance. We also investigate prominent deployed payment schemes prior to Bitcoin that seek to achieve those properties.

PAYMENT SYSTEMS ARCHITECTURE

As the name suggests, payment systems facilitate the exchange of money between two entities—a payer and a payee. Apart from the payer and payee, a payment system traditionally involves two more entities; one entity that manages assets and/or funds on behalf of the payer, known as the issuing bank (or issuer), and another entity that maintains an account for the payee, known as acquiring bank, or acquirer.1 For simplicity, we will use the terms payer/payee interchangeably to refer to the buyer/merchant, and we refer to all other parties as users. [1]

In what follows, we adapt the classification of payment systems from [1]. Namely, we distinguish between cash-like payments, where payers need to withdraw their funds before using them in payments and check-like payments, in which the payers do not need to engage in a withdrawal operation prior to committing to a payment (and the money withdrawal takes place later in time). Figures 2.1 and 2.2 depict the respective architectures of cash-like and check-like systems.

The operations of a typical cash-like system are depicted in Figure 2.1. In a cash-like system, the payer's account is charged before the actual payment takes place. That is, the payer first contacts the issuer to withdraw some funds from his or her account. The payer can obtain his or her funds in various forms (e.g., in a credited smart-card, electronic cash). The payer and payee subsequently interact for the requested payment amount to be deducted from the payee’s funds. The acquirer is made aware of the payment through a special deposit operation, where the payee deposits the payments that he or she has received.

The interactions of users and banks within check-like system are depicted in Figure 2.2. As opposed to cash-like systems, in check-like payments, the account of the payer is charged after the payment actually takes place (or concurrently with the payment). The latter case captures a credit card payment. Typically, in a check-like system, a payment request is initiated by the payer who sends the payee a check paying the latter. The payee forwards the request to the acquirer that notifies the issuer. The issuer evaluates the payment request and if it deems it valid, it settles the payment with the acquirer. Depending on the protocol, the issuing bank may send a message to the payer requesting a final approval of the payment or a notification that the payment was successfully processed (if the payment request already contains enough information).

Another popular means of classifying payment schemes is to categorize them into interactive and noninteractive based on whether they require the active participation of both parties.

Extensions of such architectures incorporate mediators that perform the payments on behalf of the users following the user requests. Naturally, in mediator- based payment systems, payers do not directly communicate with their bank account. Instead, they manage their funds through accounts opened with a third-party that is further responsible to send user-authenticated payment requests as defined by the protocol. Mobile phone-enabled payments can be considered as prominent example of such payments. Another variant of such architectures involves systems like PayPal [2], where users open an account to which they transfer money from their bank account. Payments can be executed in this way by any user who owns a PayPal account.

Cash-like payment system architecture

Figure 2.1 Cash-like payment system architecture.

Depending on the type of interaction, such mediators can also play the role of payment escrows; these are entities that can monitor a particular transaction and ensure the proper exchange of money and goods before the payments are confirmed. Though such a functionality has been popular during the last few years, older systems such as PayPal can be considered as pioneering examples of this category.

  • [1] In practice, the acquirer and issuer can represent the same physical entity (e.g., bank).
 
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