A holiday gift to e-retailers, with a promise of more to come

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Mott says Fed staffers are discussing whether it’s time to force U.S. banks and merchants to move to chip cards. That would be a sizable investment for the banks, and for retail chains that would have to upgrade the card terminals at their checkout counters. But, at least based on the experience so far in Europe, where all credit and debit cards are chip cards, it’s not likely to lead to consumers adding chip card readers to their PCs so they can use the chip, and the related PIN that unlocks the chip, to buy online.

The solution for e-commerce may come from the mobile phone, Mott says. He notes that most mobile phones in the world use GSM technology that requires each handset to have a built-in chip card known as a SIM card. (Two of the four major U.S. mobile carriers—AT&T and T-Mobile also use GSM.) Those SIM cards could be used to generate authorization codes after the consumer enters her PIN, just as chip cards do at the point of sale in countries that use chip technology. And with more mobile phones being built with a wireless technology known as NFC, Mott argues that within a few years many consumers will have phones that will be able to transmit that authorization data to their PCs and on to merchant web sites.

Here's how it would work: A web shopper types her PIN into her mobile phone, the chip in the mobile phone generates an authorization code, the phone sends that wirelessly to PC, the PC transmits it to the merchant web site. The web merchant sends the code to the bank that issued the consumer’s card as proof the transaction was authorized. And nowhere in that transaction flow is the actual card number exposed.

There’s a lot of work to get there, but Mott believes we could start seeing a system like this within a few years. What’s more, he argues that national security concerns are likely to push the government and the Fed to insist that banks, merchants and payments processors upgrade the electronic payments system to reduce fraud. If that proves to be the case, the Fed’s recent proposal on reducing debit card fees will be just the beginning of much more far-reaching changes coming in payments.