E-Commerce

UNIT- III

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 Electronic Payment Systems
• Electronic payment systems and e-commerce are intricately linked
given that on-line consumers must pay for products and services.
• An important aspect of e-commerce is prompt and secure payment,
clearing, and settlement of credit or debit claims. On-line sellers face a
problem of paying for goods and services. What currency will serve as
the medium of exchange in this new market place.
• Payment and settlement is a potential bottleneck in the fast-moving
electronic commerce environment if one depends on conventional
payment methods such as cash, checks, bank drafts, or bills of
exchange.
• New methods of payment are needed to meet the emerging demands of
e-commerce. These neo-payment instruments must be secure, have a
low-processing cost, and be accepted widely as global currency tender.

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 Electronic Payment Systems

• Electronic payment systems are getting used in banking,

retail, health care, on-line markets and even government.
The emerging electronic payment technology was labeled
as Electronic Fund Transfer (EFT). EFT is defined as “any
transfer of funds initiated through an electronic terminal,
telephonic instrument, or computer or magnetic tape so as
to order, instruct, or authorize a financial institution to
debit or credit an account”. EFT utilizes computer and
telecommunication components both to supply and to
transfer money or financial assets.

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 Electronic Payment Systems

• Work on EFT can be segmented into three broad categories:

•  Banking and Financial Systems:
–  Large scale or wholesale payments
– (Ex: Bank – to- Bank Transfer)
– Small scale or retail payments (Ex: ATM and Cash
dispensers)
– Home banking (Ex: Bill Payment)
•  Retailing Payments:
– Credit Cards (Ex: VISA/Master Cards)
– Private label Credit/debit cards (Ex: JcPenny Card)
– Charge Cards (Ex: American Express)

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 Electronic Payment Systems
• Work on EFT can be segmented into three broad categories:
•  On-line electronic Commerce Payments
– Token based payment systems
– Electronic Cash(Ex: Digicash)
– Electronic Cheques ((Ex: Netcheque)
– Smartcards or debit cards
– Credit Card based payment systems
»  Encrypted Credit Cards
» Third party authorization numbers
• Digital token-based electronic payment systems
• Non of the banking or retailing payment methods are completely
adequate in their present form for the consumer-oriented e-commerce
environment. Their deficiency is their assumption that the parties will
at some time or other be in each other’s physical presence or that there
will be a sufficient delay in the payment process for frauds, overdrafts,
and other undesirables to be identified and corrected
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 Electronic Payment Systems
• Digital token-based electronic payment systems
– These assumptions may not hold for e-commerce and so many of
these payment mechanisms are being modified and adapted for
the conduct of business over networks. New forms of financial
instruments are being developed like “electronic tokens” in the
form of electronic cash / money or cheques. Electronic tokens are
designed as electronic analogs of various forms of payment backed
by a bank or financial institution. Electronic tokens are equivalent
to cash that is backed by a bank
– Electronic Tokens are of three types:
• Cash or Real time: Transactions are settled with the exchange
of electronic currency.
• Debit or prepaid Card: Users pay in advance for the privilege
of getting information.
• Credit or postpaid: The server authenticates the customers and
verifies with the bank that funds are adequate before purchase
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 Electronic Payment Systems

•  Dimensions that are used for analyzing the different initiatives:

• The nature of the transaction for which the instrument is
designed. The parties involved, the average amounts, and the
purchase interaction are to be identified
• The means of settlement used – tokens must be backed cash,
credit, electronic bill payments etc.
• Approach to security, anonymity and authentication –
encryption can help with authentication and asset management
• The question of risk – who assumes what kind of risk at what
time? Risk arises if the transaction has long lag times between
product delivery and payments to merchants.

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 Electronic Payment Systems
• Electronic Cash:
• Electronic Cash combines computerized convenience with security
and privacy that improve on paper cash. E-cash focuses on replacing
cash as the principal payment vehicle in consumer oriented electronic
payments.
–  Properties of Electronic Cash:
•  E-cash must have the following four properties:
–  Monetary value – E-cash must be backed by either cash, bank
authorized credit or a bank certified cashier’s check.
– Interoperability – E-cash must be exchangeable as payment for
other e-cash, paper cash, goods or services, lines of credit,
deposits in banking accounts, bank notes or obligations, electronic
benefits, transfers and the like.

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 Electronic Payment Systems
–  Properties of Electronic Cash:
•  E-cash must have the following four properties:
– Retreivability – E-cash must be storable and retrievable. Remote
storage and retrieval would allow users to exchange e-cash from
home or office or while travelling.
– Security – E-cash should not be easy to copy or transfer with
while being exchanged; this includes preventing or detecting
duplication and double spending.
– Purchasing e-cash from currency servers:
• Electronic cash is based on cryptographic systems called “ digital
signatures” which involves a pair of numeric keys that work in
tandem: one for locking (encoding) and the other for unlocking
( decoding). Messages encoded with one numeric key can only be
decoded with the other numeric key.

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 Electronic Payment Systems
–  Purchasing e-cash from currency servers:
• The purchase of e- cash from an on-line currency server involves two
steps.
–  Establishment of an account and
– Maintaining enough money in the account to back the purchase.
• All customers must have an account with a central on-line bank
•  Consumers use the e-cash software on the computer to generate a
random number, which serves as the “note”. In exchange for money
debited from the customer’s account, the bank uses its private key to
digitally sign the note for the amount requested and transmits the note
back to the customer.
•  Electronic cash can be completely anonymous. Anonymity allows
freedom of usage. When the e-cash software generates a note; it masks
the original number or “blinds” the note using a random number and
transmits it to a bank. The “blinding” carried out by the customer’s
software makes it impossible for anyone to link payment to payer.
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 Electronic Payment Systems

–  Purchasing e-cash from currency servers:

•  Using the Digital Currency: Once the tokens are purchased; the e-
cash software on the customer’s PC stores digital money undersigned
by a bank. The user can spend the digital money at any shop accepting
e-cash, without having to open an account.
– Two types of transactions are possible:
• Bilateral -Typically transactions involving cash are bilateral or two
party transactions where by the merchant checks the veracity of the
note’s digital signatures by using the bank’s public key.
• Trilateral Transactions involving financial instruments other than
cash are usually trilateral or three party transactions, where by the
“notes” are sent to the merchant, who immediately sends them
directly to the digital bank. The bank verifies the validity of these
“notes” and that they have not been spent before.

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 Electronic Payment Systems
• Drawback of e-cash is its inability to be easily divided into smaller amounts.
Customers are issued a single number called an “open check” that contains
multiple denomination values sufficient for transactions up to a pre-described
limit. At payment time, the e-cash software on the client’s computer would
create a note of the transaction value from the “open check”.
• Business Issues and Electronic Cash:
– Electronic cash fulfils two main functions: as a medium of exchange and as
a store of value.
– Controversial aspects of e-cash are those that relate to the store of value. If
e-cash had to be convertible into legal tender on demand, then for every
unit there would have to be a unit of cash reserved in the real economy.
This creates problems, because in an efficient system, if each e-cash unit
represents a unit of real cash, then positive balances of e-cash will earn no
interest.

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 Electronic Payment Systems
• Business Issues and Electronic Cash:
–  Currency fluctuations in international finance pose another problem.
Unless, we have one central bank offering one type of electronic
currency, it is very difficult to see e-cash being very prominent except
in narrow application domains.
–  If e-cash started to bypass regulated foreign exchange markets by
developing its own grey market for settlement, then governments
might be provoked into trying to clamp down on it.
–  Because of these obstacles, e-cash in its early forms may be
denominated in single currencies and exchanged at conventional
market rates.

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 Electronic Payment Systems
• Operational Risk and Electronic Cash:
– Operational risk associated with e-cash can be mitigated by imposing
constraints such as limits on:
• The time over which a given electronic money is valid
• How much can be stored on and transferred by electronic money
• Number of exchanges that can take place before a money needs to be
redeposited with a bank or financial institution
• The number of such transactions that can be made during a given
period of time. 
• Exchanges could also be restricted to a class of services or goods.
– The objective of imposing constraints is to limit the issuer’s liability. A
well designed system could enforce a policy involving both transactions
size and value with time. Exchanges could also be restricted to a class of
services or goods.

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 Electronic Payment Systems
•  Legal Issues and Electronic Cash:
• Transaction based taxes account for a significant portion of state and
local government’s revenue. If e-cash really is made to function the
way paper money does, payments could be made in this new forms of
currency because there would be no problems of bulk and no risk of
robbery. The threat to the government’s revenue flow is a very real
one, and officials in government are starting to take cognizance of this
development and to prepare their responses.
•  Any thing that makes cash substantially easier to use in a broader
range of transactions holds the potential to expand the underground
economy to proportions posing even more serious threats to the
existing legal order.

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 Electronic Payment Systems

• Electronic Checks:
• Electronic checks are another form of electronic tokens. They are
designed to accommodate the many individuals and entities that might
prefer to pay on credit or through some mechanism other than cash.
• Buyers must register with a third party account server before they are
able to write electronic checks. The accounts server also acts as a
billing service. Once registered a buyer can then contact sellers of
goods and services. To complete a transaction, the buyers send a check
to the seller for a certain amount of money. When deposited, the
check authorizes the transfer of account balances from the account
against which the check was drawn to the account to which the check
was deposited.
• On receiving the check, the seller presents it to the accounting server
for verification and payment. The accounting server verifies the
digital signature on the check using the authentication scheme.

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 Electronic Payment Systems

• Electronic Checks:
 
• Electronic Checks have the following advantages:
– They work in the same way as traditional checks, thus simplifying
customer education.
– Electronic checks are well suited for clearing micro payments.
– Electronic checks create float and the availability of float is an
important requirement for commerce.
– Financial risk is assumed by the accounting server and may result
in easier acceptance.

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 Electronic Payment Systems
• Electronic Checks:
 

  Transfer electronic check

Payer Payee

Forward check for payer

authentication
Deposit check
Bank

Accounting Sever
Payment transaction sequence in an electronic check system
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 Smart card payment Systems

• Smart Cards and Electronic Payment Systems:

• Smart Cards are credit and debit cards and other card products enhanced
with microprocessors capable of holding more informant than the
traditional magnetic stripe.
• Smart card technology is widely used in countries such as France,
Germany, Japan and Singapore to pay public phone calls, transportation
and shopper loyalty programs.
•  Smart cards are basically of two types:
• Relationship based smart credit cards
• Electronic purses also known as debit cards.
• Relationship based Smart Cards:
• A relationship-based smart card is an enhancement of existing card services
and/or the addition of new services that a financial institutions delivers to
its customers via a chip based card or other devices.

 
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 Smart card payment Systems

– Relationship-based products offer the following:

• Access to multiple accounts, such as debit, credit, investments or stored
value for e-cash, on one card or an electronic device.
• A variety of functions, such as cash access, bill payment, balance
inquiry or funds transfer for selected accounts.
• Multiple access options at multiple locations using multiple device types
such as ATMs, personal computer, Personal Digital Assistant (PDA).
• Electronic Purses and Debit Cards:
– “Electronic Purses” are wallet sized smart cards embedded with
programmable microchips that store sums of money for people to use
instead of cash. After the purse is loaded with money it can be used to pay
for in a vending machine equipped with a card reader.
– When the balance on an electronic purse is depleted, the purse can be
recharged with more money. 
– For merchants, smart cards are a very convenient alternative to handling
cash.
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 Smart card payment Systems

• Smart-card readers and smart phones

– Benefits of smart cards will rely on the availability of devices called smart
card readers that can communicate with the chip on a smart card. In
addition to reading from and writing to smart cards, these devices can also
support a variety of key management methods.
– Card readers in the form of screen phones are becoming more prominent.
The phone prompts users through transactions using menus patterned
after those found on automated teller machines
– Smart card readers can be customized for specific environments
• Business issues and smart cards
– For merchants smart cards are a very convenient alternative to handling
cash
– Security of smart cards and their ability to authenticate themselves will
make them useful for payments related to electronic commerce services

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 Credit card payment systems

• Credit Card based Electronic Payment Systems:

– To avoid the complexity associated with digital cash and electronic checks,
consumers and vendors are looking at credit card payments on the
Internet as one possible time-based alternative. If consumers want to
purchase a product or service, they simply send their credit card details to
the service provider involved and the credit card organization will handle
this payment like any other
– Credit Card Payment on on-line networks can be categorized as
• Payments using plain credit card details: The easiest method of
payment is the exchange of unencrypted credit cards over a public
network such as telephone lines or the Internet.The low level of
security inherent in the design of the Internet makes the method
problematic. Authentication is also a significant problem.

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 Credit card payment systems
– Credit Card based Electronic Payment Systems:
• Payments using encrypted credit card details: Though encryption of
credit card makes sense the cost would prohibit low-value payments
by adding costs to the transaction.
• Payments using third party verification: One solution to security and
verification problems in the introduction of a third party. A company
that collects and approves payments from one client to another.
• Encryption and Credit Cards: To make a credit card transaction truly secure
and non-refutable, the following sequence of steps must occur before actual
goods, services or funds flow:
– A customer presents his or her credit card information securely to the
merchant.
– The merchant validates the customer’s identity as the owner of the credit
card account.
– The merchant relays the credit card charge information and signature to
its bank or on-line credit card processors.
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 Credit card payment systems
– The bank or processing party relays the information to the customer’s
bank for authorization approval.
– The customer’s bank returns the credit card data charge authentication
and authorization to the merchant.
Customer
Merchant’s Server
Send encrypted
Credit card number
Send information

Check for credit card

Monthly OK Authenticity and
Purchase sufficient funds
statement
Verify

Authorize

Customer’s bank On-line credit card processors

Processing payments using encrypted credit cards

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 Credit card payment systems

• Third-party processors and credit cards

• In third party processing, consumers register with a third party on the
Internet to verify electronic microtransaction. On-line third party (OTTP)
have created a process that they believe will be a fast and efficient way to buy
information on-line
• The consumer acquires an OTTP account number by filling out a
registration form.
• To purchase an article on-line, the consumer requests the item form
the merchant by quoting the OTTP account number
• The merchant contacts the OTTP payment server with the
customer’s account number
• The OTTP payment server verifies the customer’s account number
for the vendor and checks for sufficient funds
• The OTTP payment server sends an electronic message to the buyer.

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 Credit card payment systems
• Third-party processors and credit cards
– If the OTTP payment server gets a Yes from the customer, the
merchant is informed and the customer is allowed to get the material
– The OTTP will not debit the buyer’s account until it receives
confirmation of purchase completion
• Pros and Cons of Credit Card based payment:
– Credit cards have advantages over checks in that the credit card company
assumes a larger share of financial risk for both buyer and seller in a transaction.
– Record keeping with credit cards is one of the features consumers value most
because of disputes and mistakes in billing
–  Disadvantage to credit cards is that their transaction are not anonymous, and
credit card companies do in fact compile valuable data about spending habits.
–  The complexity of credit and processing takes place in the verification, a
potential bottleneck.
–  Encryption and transaction speed must be balanced. On-line credit card users
must find the process to be acceptable simple and fast.

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 Risk in Electronic Payment system

• Risk and Electronic Payment Systems:

• Operation of the payment systems incurs three major risks.
» Fraud or mistake
» Privacy Issues
» Credit Risk
• Risks from Mistake and Disputes:
– All electronic payments systems need some ability to keep automatic records. Features
of these automatic records include
» Permanent storage
» Accessibility and traceability
» A payment system database
» Data transfer to payment maker, bank or monetary authorities
• Anonymity is an issue that will have to be addressed through regulation covering consumer
protection in electronic transactions.

 
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 Risk in Electronic Payment system

• Managing Information Privacy:

– The electronic payment system must ensure and maintain privacy. Privacy
must be maintained against eavesdroppers on the network and against
unauthorized insiders. For many types of transactions, trusted third party
agents will be needed to vouch for the authenticity and good faith of the
involved parties.
• Managing Credit Risk: Credit or systemic risk is a major concern in net
settlement systems because a bank’s failure to settle its net position could lead
to a chain reaction of bank failures.
• A digital central bank guarantee on settlement removes the insolvency test
from the system because banks will move readily assume credit risks from
other banks. Without such guarantees the development of clearing and
settlement systems and money markets may be impeded

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 Design of Electronic Payment system
• Designing Electronic Payment Systems: The following factors must be
addressed before any new payment method can be successful.
– Privacy: A user expects to trust in a secure system
– Security: A secure system verifies the identity of two party transactions
through “user Authentication” and reserves flexibility to restrict
information/services through access control.
– Initiative Interface: The payment interface must be an easy to use as a
telephone.
– Database Integration: Banks should integrate all databases together and to
allow customers access to any of them while keeping the data up-to-data
and error free.
– Brokers: A “network banker” must be in place.
–  Pricing: Pricing should be affordable by the consumer and it must be
recognized that without subsidies it is difficult to price all services
affordably.
– Standards: Without standards, the welding of different payment users into
different networks and different systems is impossible.
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