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PAGE ONE Economics


The Smart-Chip Credit Card:
A Current Solution
Jeannette N. Bennett, Senior Economic Education Specialist

Card-not-present (CNP) transaction: A card
transaction in which the card itself is not physically present. The cardholder provides information including the card number, expiration date,
name of cardholder, and security code to a
Card-present (CP) transaction: A face-to-face
card transaction in which the card is physically
swiped or inserted into a card reader terminal.
Card reader: A device designed to read or decode
the encoding on plastic cards.
EMV chip specifications: Specifications developed
by Europay, MasterCard, and Visa defining
requirements for using chip cards worldwide.
Fraud: Intentional and deliberate misrepresentation of information in violation of laws and
Issuer: Any financial institution that issues or
causes credit cards to be issued.
Magnetic stripe: A magnetic stripe on the back of
a plastic card that activates card information
stored on the card when swiped through a
card reader; also called a magnetic strip or
Personal identification number (PIN): A required
code known only by the cardholder that is
used to make transactions; the PIN is entered
into a terminal and sent to an authorizing entity
to verify the account.
Point-of-sale (POS) terminal: An electronic device
for the acceptance of payment cards; POS refers
to the area or location where customers can
pay for their purchases.
Skimming: An illegal method of stealing credit
card information by using a small electronic
device that scans and stores card data. The
stolen credit card information can be used to
make fraudulent purchases or clone new cards.
SmartPay Program: The world’s largest government charge card and commercial payment
program that allows authorized government
employees to make purchases on behalf of
the U.S. government.

March 2016

“Once a new technology rolls over you, if you’re not part of
the steamroller, you’re part of the road.”

—Stewart Brand, Editor of the Whole Earth Catalog

“New and improved” credit cards are appearing in wallets of consumers
across the United States. Designed for additional security for consumers
and businesses, the new cards command the attention of consumers,
merchants, and financial institutions. They look like the traditional old
cards with one difference: a small, square, metallic computer chip appears
on the front of each card. The card is known by several names, including
smart card, smart-chip card, chip-enabled smart card, chip card, chip-andsignature card, chip-and-PIN (personal identification number) card, and
EMV (named for Europay, MasterCard, and Visa) chip card (see the table).1
Given all these names, it’s understandable that the transition to the new
card has prompted questions and even some confusion. For simplicity,
this essay primarily refers to the new cards as smart cards or chip cards.

Changes in Procedures and Processes
For a point-of-sale (POS) transaction, the smart card functions the same as
the traditional magnetic stripe card but some procedures and processes
have changed. When a magnetic stripe card is swiped for a transaction,
unencrypted data stored on the card are read by the terminal. The terminal
processes and sends the uncoded information to the card issuer. Within
seconds, the issuer’s computer verifies and either approves or declines the
requested transaction.2 In a smart card transaction, the card is not swiped
but is inserted, or “dipped,” into a chip card reader terminal. Payment data
are embedded on the chip3 and the terminal enables the chip to process
information. The payment application embedded on the chip completes
processing, stores encrypted (coded) data, and generates a new code for
each transaction. During a transaction, encoded data flow between the
smart card and the issuing institution for account authorization to approve
or decline the transaction.

Federal Reserve Bank of St. Louis |

PAGE ONE Economics®

Federal Reserve Bank of St. Louis |


Credit Card Terminology


Chip card

A card containing a computer chip that stores, processes, and encrypts (encodes) information when used at a
chip card reader terminal.

Chip-and-PIN card

A chip card that requires a personal identification number (PIN) at the point of sale (POS) to complete a

Chip-and-signature card

A chip card that requires a signature at the POS to complete a transaction.

Credit card

A card that represents an agreement between a lender—the institution issuing the card—and the cardholder.
Credit cards may be used repeatedly to buy products or services or to borrow money on credit. Credit cards are
issued by banks, savings and loan associations, retail stores, and other businesses.

A Credit Card Timeline
As the forerunner of the smart card, the magnetic stripe
card was the hub of the credit card market for years. In
2011, the magnetic stripe was listed as one of IBM’s top
100 contributions to society as part of the company’s
100-year anniversary celebrations.4 Since the 1970s, this
development has boosted rapid growth in the credit card
market. Federal Reserve statistics validate the impact of
the magnetic stripe: U.S. credit card balances grew from
$9 billion in early 1973 to $890 billion in October 2015.5
But as the saying goes, “All good things must come to
an end.” After decades of low-cost efficiency in the credit
card market, new technologies and security concerns
demanded a change in card design and the magnetic
stripe era began its descent into history.
Although new to the United States, chip cards have
coexisted with magnetic stripe cards for several years.
Because the magnetic stripe card was already successfully in use, the chip card industry enjoyed the benefit
of time to test, improve, refine, and perfect the new
technology. Invented in the early 1970s, chip cards were
first tested in France in the 1980s. By 1994, a Frenchdeveloped chip was used for all credit cards issued by
French banks. That same year, as more countries became
interested in using the chip card, three international payment systems—Europay, MasterCard, and Visa—began
a global partnership to develop specifications for a chip
card that could be used worldwide. Several versions
evolved, with improvements made before the most
recent chip specifications were released.6 Finally, in 1999,

a separate company—EMVCo—was created to manage
and oversee EMV chip specifications.7
At least for some time the new smart cards will include
the traditional magnetic stripe on the back. This dualtechnology is necessary since some businesses have not
yet upgraded to the new chip card reader terminals.

Smart Cards Provide a Solution
As much of the world embraced the EMV global standard
chip technology, the United States resisted and became
the last developed country to rely on magnetic stripe
cards.8 The United States already had advanced fraud
management methods in place for magnetic stripe cards
and the perceived benefit of migrating to the smart card,
with inherent cost and investment by issuers and merchants, did not seem justified.
However, as more cases of credit card hacks surfaced
and the number of high-profile data breaches swelled,
the growing fraud problem garnered increased attention. Concerns regarding fraud involving card-present
(CP) transactions included credit card counterfeiting,
skimming of personal and financial data, and fraudulent
transactions made with lost or stolen credit cards. In each
case, fraudulent transactions are made with an altered,
stolen, or cloned card.9 The smart card, designed specifically to reduce fraud and significantly improve security
for POS payment transactions, offered a solution. Because
smart cards generate a new security code for each transaction, the specifications make cloned, stolen, or skimmed
data useless to fraudsters. The unique and changing

PAGE ONE Economics®
security code is the key for addressing CP fraud and providing a more secure payment system.
To strongly encourage merchant participation in the
chip card solution, the major U.S. credit card issuers—
MasterCard, Visa, Discover, and American Express—
established October 1, 2015, as the date for merchants
to establish responsibility for CP fraud. After this date, if
merchants had not upgraded to accept the new chip
cards, they would be responsible for any fraud liability
and risk the high costs of possible data breaches. Liabilityshift dates are set for October 2016 for ATMs and October
2017 for fuel pumps. This extended time allowance was
granted because of the increased cost and complexity
of the transition.10

Government Endorsement
Although the government did not mandate the switch
to the new chip card, it did endorse the change through
an executive order signed in late 2014. In early 2015,
the federal government began to use chip cards through
its SmartPay program.11 This program provides credit
cards to government employees for use in conducting
government business. The government-issued cards are
designed as chip-and-PIN cards, which provides an additional layer of security, although most other U.S. issuers
are implementing primarily the chip-and-signature card
initially. Additionally, upgrades have been initiated for
all government-owned POS terminals to become chip
card reader terminals.12 These actions clearly illustrate
the U.S. government’s commitment to adopt smart card

Migration Schedules
Migration schedules for the smart card rollout vary by
issuer. While some issuers have committed to issuing the
new cards to all customers as quickly as possible, others
have issued the cards first to customers who are new,
have requested new cards, travel internationally, or have
greater fraud risk. Regardless of the rollout plan, the number of smart cards continues to increase substantially.
An estimated 50 percent to 70 percent of U.S. cards had
undergone the transition to chip cards by the end of
2015.13 For comparison, a Federal Reserve study reports
that as recently as 2012 only 74 of every 100,000 CP credit
card transactions were made with a chip card.14

Federal Reserve Bank of St. Louis |


Transition Cost and Issues
The transition to the smart card is a huge task in terms
of investment, cost, and procedural changes. First, it is a
tremendous task for issuers to update the vast number
of credit cards in circulation. At the end of 2012, the
Federal Reserve reported approximately 333.6 million
credit cards in force15 and the number continues to
increase. And card issuance bears its own cost: The average cost for issuing a new smart card is $3.5016 compared
with slightly more than $1.00 for issuing a magnetic stripe
A substantial cost is involved for retailers as well to install
an estimated 12 million new POS terminals to accept the
new cards. The estimated cost of each EMV-compliant
POS terminal is between $500 and $1,000.18 And of
course, employees need training for the new procedure,
which also requires time and can be costly. Smart cards
slow the transaction process by a few seconds, which
affects the checkout process. But more importantly, each
retailer must weigh the cost and benefit to its business
of changing to the smart card technology. Upgrading
may be expensive, but the liability for any fraud and possible data breaches could be disastrous. As mentioned
earlier, the party that does not support EMV technology
will bear the liability for counterfeit and lost/stolen
(MasterCard, Visa, American Express, Discover) cards.
Finally, the transition will likely be viewed as a short-term
inconvenience for consumers. First, the smart-card transaction process takes a few seconds longer than the magnetic-stripe process to transmit the data and complete a
transaction. Second, breaking the habit of swiping the
card may be initially awkward and require practice. The
smart card terminal prompts the customer to insert, or
dip, the card into the terminal and leave it there until the
transaction is completed. The terminal may instruct the
consumer visually and/or with a beep when the card
should be removed. There may be a PIN required rather
than a signature, a possible inconvenience, but most
smart cards will continue to require a signature.

The history of credit cards is already defined; the future
is under construction. The huge task of transitioning to
the smart card is underway, so what’s to be expected in
the future? First, as the migration progresses, an increase

PAGE ONE Economics®
in fraud related to card-not-present (CNP) transactions—such as for e-commerce—is anticipated.19 The
smart card does not change anything for CNP transactions. As fraudsters move the focus of their attacks to
the CNP environment, more changes in the smart card
may evolve to address both CP and CNP transactions.
Also, most initial smart cards are designed to require a
signature. Future changes may include the requirement
of a PIN as another layer of security. Overall, there appears
to be consensus that the transition to smart cards is on
the right track. Staying on the right track means monitoring, adjusting, and making changes. Even though the
magnetic stripe card worked well for decades, changing
technology and security concerns prompted adjustments
and changes—just as they will for smart cards. n

Federal Reserve Bank of St. Louis |


Cordray, Steven. “Why Is the U.S. Card-Present Fraud Breakout Not Present?”
Retail Payments Risk Forum, Federal Reserve Bank of Atlanta, September 8, 2015;

See Kossman (2015).


Kitten, Tracy. “What’s the President’s Influence on EMV?”,
October 20, 2014;

Kitten, Tracy. “Government Rolls Out Chip and PIN: But Will Banks Be
Influenced by the Strategy?”, January 23, 2015;

Mecia, Tony. “Poll: Wealthy Getting EMV Cards First.”,
February 25, 2015;

Federal Reserve System. “The 2013 Federal Reserve Payments Study: Recent
and Long-Term Payment Trends in the United States: 2003-2012; Summary
Report and Initial Data Release.” December 19, 2013, p. 17;


Kossman, Sienna. “8 FAQs About EMV Credit Cards.”, updated
December 21, 2015;


Frellick, Marcia. “The Rise and Fall of the Credit Card Magnetic Stripe.”, June 14, 2011;


Tressler, Colleen. “What to Know about the New Credit and Debit Chip Cards.”
Federal Trade Commission, October 5, 2015;

Federal Reserve System. “The 2013 Federal Reserve Payments Study: Recent
and Long-Term Payment Trends in the United States: 2003-2012; Detailed Report
and Updated Data Release” July 2014, p. 66;

See Kossman (2015).


Frellick, Marcia. “What’s It Cost to Get a Credit Card in Your Pocket?”, August 2010;


See Kossman (2015).


See Cordray (2015).

See Frellick (2011).


Board of Governors of the Federal Reserve System. “Consumer Credit–G.19.”
Various years;
6 EMVCo LLC. “A Guide to EMV Chip Technology.” Version 2.0, November 2014, p. 8;


See EMVCo, LLC (2014, p.13).


King, Douglas. “Chip-and-Pin: Success and Challenges in Reducing Fraud.”
Retail Payments Risk Forum Working Paper, Federal Reserve Bank of Atlanta,
January 2012, p.1;

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