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How Square Works: A Guide to the Payment Platform

  • How Square acts as a third-party payments aggregator and what that means for merchants and customers
  • How Square complies with the operating rules of Visa and MasterCard, and what are the implications of being an Internet Payment Service Provider or a High Risk Internet Payment Service Provider
  • How Square leverages a software platform called IP Commerce to enable its service and what are the advantages and disadvantages of this approach
  • How Square plans to expand its business by applying for a California Money Transmitter license and what are the potential opportunities and risks of this move

    What is a Third-Party Payments Aggregator?

A third-party payments aggregator (TPPA) is a type of payment service provider that processes transactions for merchants that do not have their own merchant accounts. A merchant account is a bank account that allows a business to accept credit and debit cards, and it usually requires a contract, fees, and underwriting. A TPPA, on the other hand, acts as a middleman between the merchants and the card networks, such as Visa and MasterCard, and uses its own merchant account to process the payments. This way, the merchants can avoid the hassle and cost of setting up and maintaining their own merchant accounts, and the customers can pay with their cards without any issues.
Square is one of the most well-known examples of a TPPA, and it allows merchants to sign up for its service online, without any contracts, monthly fees, or credit checks. Square provides the merchants with a card reader that plugs into a smartphone or tablet, or a point-of-sale system that connects to the internet, and charges a flat rate per transaction, regardless of the card type or amount. Square then deposits the funds into the merchants’ bank accounts, usually within one or two business days.

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How Does Square Follow the Operating Rules of Visa and MasterCard?

As a TPPA, Square has to comply with the operating rules of the card networks, such as Visa and MasterCard, that govern the payment industry. These rules specify the standards, procedures, and responsibilities of the parties involved in the payment process, such as the card issuers, the card acquirers, the merchants, and the payment service providers. The rules also define the categories and requirements of different types of payment service providers, such as Internet Payment Service Providers (IPSPs) and High Risk Internet Payment Service Providers (HRIPSPs).
An IPSP is a payment service provider that processes transactions for merchants that sell products or services that they do not own or control, such as online marketplaces, travel agencies, or digital content providers. An HRIPSP is an IPSP that operates in high-risk industries, such as gambling, adult entertainment, or pharmaceuticals. Both IPSPs and HRIPSPs have to meet certain criteria and obligations, such as registering with the card networks, disclosing their business model and merchant portfolio, and implementing fraud prevention and customer protection measures.
Square falls under the category of an IPSP, as it processes transactions for merchants that are selling a product or service that the master merchant account does not own. This category was originally created for PayPal, which was the first TPPA to operate in the online space, but it was later extended to other TPPAs that offer similar services, such as Square. Square has to follow the operating rules of Visa and MasterCard as an IPSP, and it has to register with the card networks, disclose its business model and merchant portfolio, and implement fraud prevention and customer protection measures.

How Does Square Use IP Commerce to Enable Its Service?

Square is not the only TPPA that operates in the payment industry, and it faces competition from other players, such as Intuit, Shopify, and Stripe. To differentiate itself and offer a better service to its merchants and customers, Square leverages a software platform called IP Commerce, which is a company that provides payment infrastructure and technology to payment service providers, such as Square.
IP Commerce enables Square to connect to multiple card networks, banks, and processors, and to access various payment features and functionalities, such as tokenization, encryption, authorization, settlement, and reporting. IP Commerce also allows Square to customize its payment service and to integrate it with other products and services, such as payroll, invoicing, marketing, and analytics. By using IP Commerce, Square can offer a more flexible, scalable, and secure payment solution to its merchants and customers, and to innovate and expand its business.

How Does Square Plan to Grow Its Business by Applying for a California Money Transmitter License?

Square is not only a payment platform, but also a financial services company that offers various products and services to its merchants and customers, such as Square Cash, Square Capital, and Square Card. To grow its business and to offer more value to its users, Square plans to enter new markets and to launch new features and functionalities. One of the steps that Square has taken to achieve this goal is to apply for a California Money Transmitter License in 2012, which could imply any of the following:
– A move into P2P payments, which would allow users to send and receive money from their Square balance, rather than using a credit or debit card. This would reduce the transaction costs and increase the convenience and security of the users.
– A move into international remittance, which would allow users to send and receive money across borders, using their Square balance or a linked bank account. This would open up a huge market opportunity and provide a cheaper and faster alternative to traditional remittance services.
– A move into bill pay, which would allow users to pay their bills, such as utilities, rent, or subscriptions, using their Square balance or a linked bank account. This would simplify the payment process and offer more convenience and control to the users.
– A move into Square accounts with prepaid balances and ACH funding, which would allow users to store and manage their money in a Square account, and to fund it using a bank transfer or a card. This would help Square to increase its margins, as it would reduce the card processing fees and increase the user engagement and loyalty.
– A very conservative General Counsel, who wants to ensure that Square complies with all the relevant laws and regulations, and to avoid any potential legal issues or penalties.
To operate as a money transmitter, Square would also need to register as a Money Services Business (MSB) with the Financial Crimes Enforcement Network (FinCEN), which is a bureau of the U.S. Department of the Treasury that oversees the compliance and enforcement of the anti-money laundering and counter-terrorism financing laws and regulations. This would require Square to implement certain policies and procedures, such as customer identification, transaction monitoring, record keeping, and reporting.

Conclusion

Square is a payment platform that allows merchants to accept credit and debit cards, as well as other forms of payment, using a mobile device or a point-of-sale system. Square also offers various products and services for businesses, such as payroll, invoicing, marketing, and analytics. Square works by acting as a third-party payments aggregator, following the operating rules of Visa and MasterCard, using a software platform called IP Commerce, and applying for a California Money Transmitter License. Square faces various benefits and challenges in its business, such as offering a convenient and cost-effective service, complying with the payment industry standards and regulations, innovating and expanding its product portfolio, and competing with other payment service providers. Square is a company that aims to revolutionize the payment systems marketplace and to create a new market defined by itself.
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