This is part 2 of a series examining the structure of the Internet system today. The other posts in the series can be found here:
The Internet's Middlemen: PayPal, eBay, Facebook
Think about this:
In the early days of the Internet, before Visa and Amazon were created, how can you sell one good directly to a customer for cash online?
The short answer is that you can't. The long answer is that, if you were willing to accept the large counter-party risks from your customer being a fraud, you can come to an agreement online (via email or a chat channel or even a platform), and then you settle that trade by sending out your good by mail and hope that your buyer sends you a cheque by mail or does a bank transfer. But if the buyer fails to send you the money, you are left with no recourse; you can't even lodge a police report because your buyer might not be who they say they are.
The Silicon Valley Solution: Build Intermediaries
Later, the private sector stepped in and acted as the middlemen in such transactions, thereby giving us companies like PayPal, Amazon, eBay, and, also, Facebook.
These middlemen act as the guarantor in between two parties. In our earlier example, the buyer sends the cash payment to Amazon, who holds it in escrow and only releases it to the seller when the buyer receives the goods. If the seller fails to send the goods, the buyer gets a refund. If the buyer fails to send the cash to Amazon, the seller does not send the goods. If the buyer commits fraud and uses a stolen credit card, Amazon bears the loss from credit card fraud.
Amazon's, and the rest of these middlemen's, business model is based upon reducing the counter-party risk for such inter-party transactions because of the difficulty in establishing identity online. In return for their services, they take a cut from the transaction.