Closed loop vs. open loop payments

Closed and open loop payment systems are the two commonly used transaction modes in modern digital marketplaces. A closed loop payment system allows transactions within a unique network — a particular store, a family of brands, or a specific payment method. Open loop systems allow transactions across different cards, suppliers, merchants, and networks. While closed loop is more specific and exclusive, open loop is broad and more universal.

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This guide further explains the differences between closed loop and open loop payments — highlighting the benefits, advantages, and limitations of each — to help make informed financial decisions.

What is a closed loop payment system?

A closed loop payment system limits transactions to within a unique infrastructure, network, brand family, or mode of payment.

Closed loop transactions are made using cards, apps, or digital wallets specific to the provider offering them. Vendor-specific apps, for example, may encourage repeat customer visits through brand loyalty programmes and other incentives, such as pay with rewards options or store gift cards.

Closed loop encourages customers to stay within the confines of one payment ecosystem, allowing the provider greater control over their customer base, while helping create a tailored and personalised customer experience.

What are the advantages and limitations of closed loop payment systems?

Advantages of closed loop payment systems can include:

• Enhanced accuracy. Vendors can monitor and control customer activity precisely to build strong data and create a responsive experience.
• Convenience. Customers may enjoy great personalisation, loyalty benefits, and a strong sense of brand engagement, with payment options streamlined for a smooth overall user experience.
• Security. Closed loop apps or wallets may offer great security features and fraud detection. Customer data within a protected network may mean great security from phishing scams and other risky activity.
• Speed. With data, payment details, and preferences saved within a closed loop app or wallet, customers can enjoy potentially fast checkouts.

Disadvantages of closed loop payment system can include:

• Fees. Closed loop credit cards or payment solutions may come with higher interest rates or additional purchase fees.
• Limited access. Customers may prefer providers or payment options that aren’t supported by a closed loop system or app.
• Privacy. Vendors having specific access to user data, personal information, and payment history can raise privacy concerns.

What is an open loop payment system?

An open loop payment system is a more universal approach to payments that allows transactions across different networks and financial ecosystems. Open loop transactions are not confined to a specific network or retailer, instead offering a diversity of payment solutions and choices across the marketplace.

Global payment networks, such as Visa and MasterCard, are examples of open loop processing, allowing debit and credit card transactions with any vendor or merchant that accepts them. Open loop systems support compatibility among consumers, vendors, and financial institutions worldwide.

Given such wide network access, open loop systems rely on advanced technologies to maintain financial security, which may include encryption, fraud detection, EMV chip technology, and advanced identity authentication protocols.

PayPal offers more information here on how credit cards work within the open loop system.

What are the advantages and limitations of an open loop payment system?

Open loop system advantages can include:

• Convenience. Having various types of payment solutions universally accepted across borders allows for flexibility, fast access, and ease of use.
• Simplicity. A single form of payment can be accepted by a range of different providers worldwide, further streamlining the transaction process.
• Security. Sophisticated security protocols — including encryption, tokenization, biometrics, and multi-factor authorisation — help protect consumer data.

Disadvantages of open loop system can include:

• Higher fees. Transactions across multiple networks can trigger additional fees, depending on the provider, compatibility, and financial institutions involved.
• Shared data. Payment information is shared across multiple parties, and data may be potentially more vulnerable to fraud.
• Anonymity. As an anonymous user within a broad, open system, there may be less sense of brand loyalty or personal engagement as part of the user experience.

Comparing closed loop and open loop systems

Open loop and closed loop systems offer unique advantages and limitations, and both can be beneficial depending on personal needs.

When choosing between closed loop vs. open loop payment systems, it can help to consider factors like convenience, whether or not there are any additional fees involved, and how protected personal financial information is likely to be.