Closed-Loop vs. Open-Loop Payment Systems
Small business owners are tasked with many responsibilities, but none are more important than implementing a reliable and secure system for accepting credit cards, debit cards, and other forms of electronic payments. An effective payment system ensures a seamless experience for both the customer and your business.
This guide discusses two different types of payment systems: closed-loop and open-loop. Learn more about the features and benefits these systems offer below to help you choose the right one that best suits your business.
What Is a Closed-loop Payment System?
A closed-loop payment system is a financial arrangement where transactions occur within a specific network. In this system, payments are made using proprietary cards or digital wallets exclusive to the network's ecosystem. Funds loaded onto these instruments can only be used at designated merchants or service providers within the network.
Closed-loop systems offer enhanced control over transactions, allowing network operators to track spending patterns and offer tailored rewards. They often bypass traditional banking infrastructure, which reduces transaction fees. However, their usage is limited to the network's boundaries, contrasting with open-loop systems that permit wider merchant acceptance.
One of the best examples of a closed-loop payment system is store-specific apps. Starbucks' mobile app, for example, functions as a closed-loop payment system. Customers load funds onto their Starbucks account, using them exclusively at Starbucks locations for purchases and earning rewards. This system creates a dedicated spending environment, enhancing customer loyalty and streamlining transactions.
Traditional RFID wristband solutions work in a similar way, with the customer topping up a balance on the wristband itself. Billfold’s technology allows for this convenient step and also simplifies the process by linking directly to a bank card. Not only does this remove the refill step from the customer’s day, but it also empowers them to spend freely throughout an event without the risk of losing their card, exposing themselves to fraudulent purchases, or using up their phone battery during tap-to-pay transactions.
What Is an Open-Loop Payment System?
An open-loop payment system facilitates transactions across various networks, allowing broader merchant acceptance. Unlike closed-loop systems, open-loop payments are not confined to a specific retailer or service provider network. They typically involve debit or credit cards issued by financial institutions, and are usable within accepted card networks, such as Visa or MasterCard. This universality offers users flexibility and convenience.
An open-loop system relies on an extensive network of banks and payment processors to ensure interoperability between entities. While offering wider access, open-loop systems may involve higher transaction fees and less control over consumer data when compared to closed-loop systems.
Visa credit cards are an example of an open-loop payment system. They enable users to make payments globally and are accepted by a wide range of merchants. This system connects banks, cardholders, and retailers, facilitating transactions across different networks and locations. Doing so offers flexibility and convenience without merchant-specific limitations. Since Billfold’s technology lets customers link directly to a payment account, their wristband will function the same way their regular card does.
The Primary Differences Between Closed-Loop and Open-Loop Payments
Both systems offer distinct features and cater to different needs. Here's a breakdown of their primary differences.
- Network scope: Closed-loop payments are restricted to specific networks or merchants, whereas open-loop payments are widely accepted across various networks.
- Card issuance: Proprietary cards or apps are used in closed-loop systems, while open-loop systems utilize standard bank-issued credit or debit cards.
- Merchant acceptance: Closed-loop payments limit transactions to certain retailers or services. Open-loop systems allow transactions with any merchant within the card network.
- Transaction fees: Generally, closed-loop systems have lower transaction fees compared to open-loop systems.
- Consumer data control: Closed-loop systems provide more control over consumer data, which is beneficial for merchant-specific marketing and loyalty programs.
- Flexibility and convenience: Open-loop payments offer greater flexibility and convenience for consumers.
- Security and compliance: Both systems require adherence to security standards, but open-loop payments necessitate compliance with broader banking and card network regulations.
How to Accept Closed-Loop and Open-Loop Payments
To accept closed-loop payments, businesses must join a specific network or create their own proprietary system. This involves integrating software and hardware capable of processing exclusive cards or digital payments within the network.
For open-loop payments, businesses must establish relationships with banks or payment processors. This requires setting up point-of-sale systems compatible with major credit and debit card networks like Visa and MasterCard. Regular updates and compliance with security standards ensure smooth and secure transactions across various card issuers and banks.
Understanding and implementing the right type (or types) of a payment system is critical to providing secure and efficient payment options.
While closed-loop systems offer merchant-specific benefits and lower fees, open-loop systems provide broader acceptance and flexibility. With each catering to different aspects of customer transactions and business needs, choose wisely. Billfold’s cashless and contactless POS offers the best of both worlds, with the security of a closed-loop network for specific events or venues and the flexibility and convenience of open-loop systems to accommodate multiple vendors in one place. Customers can create and top up accounts to stick to a budget or link directly to a card for one-step payments throughout the day, all without a physical card ever leaving their wallet.
