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Tuesday, March 8, 2011

The death of the magnetic stripe card (and introduction of the "chip" card)...

Posted: Tuesday, March 8 2011 at 06:00 am CT by Bob Sullivan

First, we said goodbye to the floppy disk drive. Then, the Sony Walkman was unceremoniously buried.

Now, it’s time to prepare a eulogy to a gadget that's been an even bigger part of the American landscape for a much longer time -- the magnetic stripe credit card.

An ingenious technology in its time, the magnetic stripe was invented in the 1960s by marrying tape-recorder-like magnetic tape to a credit card. Magnetic tape itself was a remarkable invention, with its roots in the 1920s, when it was first used by musicians to record audio. In the 1950s, computer scientists began using it to record data, setting the stage for the “mag stripe card.”

In the 1960s, credit card fraud was skyrocketing, and clerks were stuck manually comparing account numbers embossed on cards with printed lists of accounts linked to fraud. The addition of the magnetic stripe allowed cashiers to automate this process -- one swipe and the number could be recognized by a computer. More importantly, the account number could be transmitted over a phone line to a centralized list of fraudulent accounts. The magnetic stripe had fraudsters on the run for quite a while.

But as the gadget is approaching its 50th anniversary, it's looking a little old -- as outdated, perhaps, as the IBM Selectric typewriter, which was introduced about the same time. Criminals long ago figured out how to circumvent the mag stripe’s fraud-fighting features -- really, by the mid-1980s, when IBM killed the Selectric in favor of the Wheel Writer. And now, European banks seem to have positively murderous intentions for the old faithful mag stripe.

In 2005, Eurozone banks converted their cards to the "chip and PIN" system, in which a more secure microchip embedded in the card performs most of the security functions. Because U.S. banks are still using the old system, most European banks and merchants still have to accept the old-fashioned cards and the fraud that comes with them -- and they are sick of it.

The European Payments Council recently passed a resolution (PDF) mandating that use of "use of magnetic stripe fallback (be restricted) to exceptional cases" and allowing banks to "to refuse magnetic stripe transactions if they so wish."

As a recent banking blog put it, the European council wants to "kill the old magnetic stripe."

They're 'fed up'

"European card issuers have been fed up since the Heartland Payment Systems breach," said Gartner banking analyst Avivah Litan, referring to the 2009 theft of millions of credit card numbers from the payment processor. Stolen account numbers are useless for in-store fraud where chip and PIN cards are required; but because magnetic stripe cards are easily copied and forged by criminals, stolen account numbers still have great value. "The mega-million-dollar investments they made in chip cards were defeated by their cardholders shopping, traveling and eating out in the U.S. using their mag-stripe enabled credit and debit cards ... European issuers have been talking about stopping their cardholders from using the mag stripe on their plastic cards since that time, and they are still fed up."

The divergence of fraud-fighting systems on either side of the Atlantic -- and the five-decade-long U.S. loyalty to magnetic stripes -- is less crazy than it sounds, says Benjamin Jun, vice president of technology at Cryptography Research, a firm that helps banks protect their data.

In the 1980s, as fraud-fighting efforts developed, international long-distance phone calls across Europe were very expensive. That gave European banks added incentive to make their credit cards secure on their own by developing a decentralized fraud-fighting system. That led to placing tiny computer chips on each card that were smart enough to be used for validation without the need to call a central bank. Instead, users enter PIN codes that can be checked against data on the chip for authenticity.

In the U.S., on the other hand, telecommunications costs were relatively inexpensive, so it made sense for American banks to maintain their centralized fraud systems and continue to have merchants "phone home" with each transaction.

"In the U.S. it cost a quarter to clear a transaction. In Europe, the costs were much higher. So they solved the problem by throwing more money at it," Jun said. "Their system has been upgraded more quickly because their fraud rates required it."

While the European payments industry hopes its declarations will prod U.S. banks into upgrading systems here, there is little chance that U.S. card issuers can be bullied to quickly adopt the Chip and PIN system. Already, several celebrated attempts to issue so-called smart cards -- such as the American Express Blue card in the late 1990s -- have fallen flat. In fact, Jun thinks it’s likely the U.S. system will skip over the European system and adopt even smarter card technology, such as the Near Field Communication chip, which allows consumers to make payments wirelessly without removing their cards -- or for that matter, their cell phones -- from their pockets.

Either way, however, the old mag stripe seems to be clearly on its last legs.

"Everyone agrees it's a matter of time," Jun said. "Our fraud rates are catching up to what Europe has."


What does this mean for today’s credit card users? The saber rattling from the European payments council won't really mean much to the day-to-day life of U.S. shoppers. But travelers heading across The Pond -- in either direction -- may encounter curious difficulties going forward, and so might U.S. merchants who count on sales to European travelers. European banks may very well choose to stop approving transactions by their consumers when a U.S. merchant tries to use a magnetic stripe for authentication -- few U.S. merchants have the capability of using smart card chips for approvals. Hand-entered account numbers will be disallowed completely, under the European resolution. That might chase tourists out of U.S. shops.

Meanwhile, U.S. travelers could soon find additional trouble when making mag stripe purchases during travel in Europe. Already, some European vending machines, such as train ticket kiosks, require smart cards for purchases.

Jun, however, doesn't expect massive troubles for American tourists. After all, few European nations are in any position to turn down American dollars right now.

"I work with a lot of banks, and it is certainly in their interests that Americans overseas can make payments. They are well aware of what they need to do to put the right cards in hands of their customers," Jun said.
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