A Brief History of Chargebacks
“History, Stephen said, is a nightmare from which I am trying to awake.”
― James Joyce, Ulysses
The ostensible origin of chargebacks lies in the Truth in Lending Act (TILA) of 1968. That law guaranteed consumer protections that eventually evolved into the current form of the chargeback. Of course, a more thorough history of chargebacks reaches further back, investigating the circumstances that precipitated the creation of the consumer rights of the TILA. Examining the history of chargebacks illuminates how they work in the present. The current chargeback ecosystem came to be in response to decades worth of developments and counter-developments.
Table of Contents
- A Brief History of Credit
- A Brief History of Fraud
- Lending and Credit Regulations
- Trouble for Merchants
- The Rise of E-Commerce
- The Era of Solutions
A Brief History of Credit
“[Credit is a system whereby] a person who can't pay, gets another person who can't pay, to guarantee that he can pay.”
― Charles Dickens, Little Dorrit
Because chargebacks cannot happen without some sort of credit-based exchange, a history of chargebacks begins with the concept of credit. According to Investopedia, “Credit is generally defined as a contract agreement in which a borrower receives a sum of money or something of value and repays the lender at a later date, generally with interest.” This form of exchange is at the center of much of the contemporary payments industry. But the theoretical aspects of credit run deeper, right down to some of the basic concepts of money itself.
The theoretical history of credit reaches back at least as far as Ancient Greece. Plato advocated for the credit theory of money, arguing that currency should be an arbitrary symbol, unrelated to the material of the money itself. By contrast, Aristotle argued in favor of the theory that money is a commodity that “serves as (i) a medium of exchange, (ii) a unit of account, and (iii) a store of value.” Anthropologist David Graeber wrote a book, Debt: The First 5000 Years, asserting that the earliest monetary systems were based on debt and credit, with those models prevailing for much of known human history. Political economist Joseph Schumpeter argued that Aristotle’s “metallist” theory prevailed until the 19th century. Either way, the credit theory of money gained prominence throughout the 20th century, finally gaining total predominance with the Nixon Shock of 1971, which permanently severed American currency from the gold standard.
As the credit theory of money gained steam from the late 19th century to 1971, the use of credit as a regular method of payment has become more prominent and complex over the last 150 years. Of particular importance is the development of credit cards. While the term “credit card” first appeared in the English lexicon in Edward Bellamy’s 1887 utopian science fiction novel Looking Backward, the payment card that Bellamy described functioned more like modern debit cards. Rather, the earliest incarnation of what would now be recognizable as credit cards were items called charge coins.
First appearing in the late 19th century, these coins were issued by businesses such as department stores and hotels. They were stamped with charge account numbers (but not the names of the account holders) and were generally kept on key rings. They allowed merchants to quickly copy charge account numbers onto sales slips, in order to collect on the accounts later. In the 1930s and 1940s, merchants began using other objects for similar purposes such as charga-plates and air travel cards. The first general purpose, credit-based payment card that could be used to make purchases from multiple different merchants was the Diners Club card, first issued in 1950 followed by American Express in 1958.
The first truly modern credit cards—issued by third-party banks, accepted by large swaths of merchants across multiple industries, and part of a revolving credit financial system—were BankAmericard and Mastercharge, which were developed, implemented, and expanded over the course of the 1960s. Initially, these two cards—which later became Visa and MasterCard—gained cardholders in part by mass mailing cards, unsolicited to millions of bank customers. This predictably caused financial chaos and eventually led to the creation of new federal regulations on credit cards and banking.
Eventually, other forms of credit-based payment—such as buy now pay later (BNPL)—and other payment cards that work on different, non-credit payment terms—such as debit cards and prepaid cards—were developed and propagated.
A Brief History of Fraud
“Whoever is detected in a shameful fraud is ever after not believed even if they speak the truth.”
The recorded history of financial fraud also finds some of its roots in Greek Antiquity. Greek merchants had the option to take out insurance policies known as bottomry. This allowed the merchants to borrow against their ships in order to finance shipping endeavors, with the promise of paying back the initial costs plus interest once they sell their wares. If for some reason a merchant was unable to repay this initial investment, the lender would repossess the ship. In the 4th century BCE, a merchant named Hegestratos took out such a policy for a voyage to ship corn. However, he had no plan of repaying the loan and instead devised a scheme to keep the cargo and sink his ship in order to defraud his lender. Unfortunately for Hegestratos, his crew discovered the scheme and he drowned while trying to escape them.
The history (and prehistory) of credit is replete with similar sorts of fraud, albeit without such lethal consequences for fraudsters who get caught. The aforementioned charge coins were susceptible to fraud due to the fact they were stamped with account numbers but no identifying information for the account holder. If an unscrupulous person acquired someone else’s charge coin, they could fraudulently rack up purchases before the lost coin was reported.
The early credit cards of the 1960s offered some solutions for this problem by including the cardholder’s name and requiring matching signatures on receipts and the back of the card. But this still allowed for fraud by individuals able to forge signatures and willing to take advantage of payment verification periods that lasted several days. Card brands and issuers attempted to solve these problems with the introduction of magnetic strip technology in the late 1960s. This reduced the payment verification time to a few seconds and made fraud more difficult. However, magnetic strips were not encrypted, allowing for technologically-aided fraud.
Additionally, the aforementioned policy of mass issuing cards unsolicited opened up problems and new avenues for fraud. While some cardholders found themselves in trouble due to spending beyond what they could pay, others took advantage of inefficiencies in the system. Some would rack up debts that they had no intention to pay, with plans to avoid accountability due to mistakes such as being issued a card in someone else’s name.
This pattern of fraud techniques inspiring anti-fraud solutions which are then met with new fraud techniques continues to the present day. But in the late 1960s and early 1970s, the government took a more active regulatory role, with lasting consequences for both cardholders and merchants.
Lending and Credit Regulations
“Neither a borrower nor a lender be, for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry.”
― William Shakespeare, Hamlet
The Truth in Lending Act (TILA) of 1968 was among the first and most significant consumer credit laws of this time period. It promotes the informed use of consumer credit with regulations relating to disclosures to cardholders; consumer rights for mortgages; and rules relating to credit card billing disputes, annual percentage rate (APR), loan terms, and borrower costs. It is mostly codified in a section of the Code of Federal Regulations (CFR) known as Regulation Z. It has been amended numerous times since its initial passage.
One such amendment was the Fair Credit Billing Act (FCBA) of 1974. Among the most important provisions of this law is a regulation allowing customers to dispute billing errors by sending notice to the creditor. The cardholder has 60 days to dispute the charge with their issuer for reasons relating to lost cards, suspected fraud, and other consumer dissatisfaction such as goods or services that were not delivered. This is the regulatory mechanism that precipitated the creation of the chargeback system by the banks and card brands. The Electronic Fund Transfer Act (EFTA) of 1978 created similar protections for debit card transactions.
Trouble for Merchants
“Man only likes to count his troubles; he doesn't calculate his happiness.”
― Fyodor Dostoevsky, Notes from Underground
While the laws of the 1960s and 1970s created the chargeback, the evolving nature of commerce, fraud, and technology in the intervening decades has made the process of managing chargebacks an increasingly complex endeavor for merchants. New regulations are created, banks and card brands institute new anti-fraud measures, the ever-changing world of commerce offers new opportunities to merchants and consumers alike, and through it all, unscrupulous actors find new ways to commit fraud.
In the 1980s, fraudsters found ways to take advantage of the lack of encryption in the magnetic stripes on cards to steal card information. This included using credit card cloners to steal and copy that information to blank cards which could then be used for fraudulent purchases. In 1993, the three largest card brands—Europar, Mastercard, and Visa—introduced a new technology known as EMV chips to their cards. These chips allowed for information encryption and two-way authentication during the purchasing process, cutting down on opportunities for fraud.
In 2015, the four major credit card companies changed their chargeback dispute policies in an effort to induce more merchants to adopt point-of-sale (POS) technology that was compatible with payment cards that contained EMV chips. Essentially the card brands shifted liability in any chargeback dispute to the merchant for non-EMV POS transactions. If the merchant swiped a card rather than used a chip reader, they would effectively lose any chargeback dispute automatically.
The Rise of E-Commerce
“Your margin is my opportunity.”
― Jeff Bezos
E-commerce is, in its broadest definition, the buying and selling of goods with the use of the internet. Ostensibly the first e-commerce transaction occurred in the early 1970s when students at Stanford University and the Massachusetts Institute of Technology arranged a sale of marijuana using Arpanet, a precursor of the internet. E-commerce’s development traced the development and wider use of the internet in general, hitting its stride in the 1990s and becoming one of the dominant forms of commerce in the 21st century. According to the U.S. Census Bureau, e-commerce accounted for 13.2% of U.S. retail sales in 2021.
As with other forms of merchant business, e-commerce has become an ever changing ecosystem in which new commerce tools, fraud techniques, fraud prevention technologies, and government regulations interact in complex ways. These issues have been exacerbated by the rise of mobile commerce, mobile payment apps, PayPal, digital wallets, new payment methods such as BNPL, and other changes.
In 2021, LexisNexis’s True Cost of Fraud study estimated that the volume of e-commerce fraud attacks increased 140% and cost 34.4% more compared to the previous year. Despite the best efforts of regulators and merchant industry players, e-commerce fraud is on the rise and is an increasing source of chargebacks. The term “e-commerce” actually comes from an early government regulation of the practice, California’s Electronic Commerce Act of 1984. But regulatory efforts to curb fraud often lag far behind the fast-paced, constantly shifting state of fraud, leaving merchants and the merchant services industry to pick up the slack.
The Era of Solutions
“But as such mere illustrations are almost universally taken for solutions (and perhaps they are the only possible humans solutions), therefore it may help to the temporary quiet of some inquiring mind; and so not be wholly without use.”
― Herman Melville, Pierre; or, The Ambiguities
For decades, the process of responding to and managing chargebacks was necessarily a haphazard and labor-intensive one for merchants. However, in recent years, card brands and merchant service providers have devised a wide swath of tools to help merchants prevent, avert, fight, and generally track their chargebacks. While none of these tools can prevent the underlying sources of chargebacks—such as cardholder dissatisfaction, merchant error, miscommunication, and the large amounts and varieties of fraud—they can help alleviate the hassles that come with responding to and otherwise managing them.
For years, merchants received chargebacks by fax or even by mail, often with little time to act upon them. Chargeback regulations necessarily favor the rights of cardholders and the complex implementation of chargebacks often leave the merchants as the last parties notified in a payment dispute. Since chargeback regulations and card brand policies impose strict timelines, the delayed, old process of informing merchants of chargebacks left them with no recourse but to accept the chargeback and its accompanying fees and consequences. But two companies founded in 2005—Verifi, a creation of a then-college student, and Ethoca, a business originally founded to provide solutions for fraud in online gambling—have offered a solution: the chargeback alert. Chargeback alerts send merchants notifications whenever a consumer contacts their issuer to initiate a chargeback. This early notification gives the merchant the opportunity to respond in a number of different ways—including issuing a refund or preparing to dispute or accept the chargeback.
Responding to alerts still requires operational expenses. In recent years, merchant service providers have developed additional solutions beyond alerts that allow for more complex chargeback mitigation strategies. These include tools that facilitate the exchange of information during the chargeback process such as Verifi Order Insight and Ethoca Consumer Clarity, identity verification tools such as 3-D Secure, automated dispute response tools such as Rapid Dispute Resolution (RDR), representment solutions, and analytics solutions.
In a sense, the history of chargebacks—and the histories of credit and fraud that precede it—involves a repetition of certain patterns: new payment methods are devised, fraudsters find ways to exploit them, anti-fraud tools and regulations attempt to avert or punish fraud, the entire payments system evolves as a result, and the process begins again. It can seem like a game of whack-a-mole. But for merchants that take proactive measures to prevent fraud and administer chargebacks, there are ways to take advantage of the vast array of payment options without being overwhelmed by the consequences of fraud and excessive chargebacks.