The full title of the now infamous Bitcoin whitepaper is “Bitcoin: A Peer-to-Peer Electronic Cash System”. The original vision was for Bitcoin to be used as a digital payment system. While Bitcoin and crypto in general has exploded in terms of adoption and global popularity, we have not yet seen the technology being used in a meaningful way as a payment solution. This is about to change. Projects such as Bitcoin’s Lightning Network and Solana Pay are targeting the payments space and for the first time have a real chance to disrupt legacy systems. This month we will dive into why crypto is perfectly placed to be a payment solution, what products already exist and how crypto payments will go mass market.
Today’s payment solutions are convoluted, confusing and antiquated. At the center of these solutions are “acquiring banks”. These are registered members of a card network, such as Visa or MasterCard, and they are responsible for accepting transactions on behalf of the debit and credit card network. Merchants are forced to work with these acquiring banks to get merchant accounts. These merchant accounts are subject to the regulations set by card associations and are crucially also subject to fees.
As of January 2022, credit card fees range from 1.3% to 3.5% per transaction, depending on the card issuer. Some cards have a minimum processing fee, regardless of the transaction size, which makes small micropayments unviable. In addition to transaction fees, merchants are usually charged scheduled merchant account fees as well as incidental processing fees related to chargebacks. In 2020, American Express made USD36bn in revenue, Visa made almost USD22bn and MasterCard made USD15bn. Over USD70bn was made by these the three companies in 2020, primarily for their role as rent-seeking middlemen enabling transactions between merchants and consumers. Crypto offers an alternative solution.
Crypto networks are built to enable peer to peer value transactions, without the need for a middleman. A merchant can create its own wallet, show a QR code to a consumer and the consumer can then send crypto directly to the merchant. On Solana, a transaction costs around USD 0.00025 regardless of the total value of the transaction. For a USD100 transaction, transacting over Solana is therefore 12,000x cheaper than transacting through a card network that charges 3%. This is an extremely attractive proposition for merchants.
Despite radically lower fees, there are a few reasons why crypto payment solutions have not yet become mainstream. While merchants benefit from the lower fees, consumers do not directly see cost savings. As a result, there has been friction in converting card carry consumers into crypto paying customers. There are several causes of friction. Firstly, in the early days of crypto, there was a lack of trusted stablecoins (tokens pegged to fiat currency). As a result, payments could only be done in digital assets that were highly volatile. Crypto users tended not to want to pay in digital tokens that they foresaw as going up in value over time and that may trigger taxable gains. Today, trusted stablecoins such as Tether or USDC are growing in popularity and circulation, allowing crypto users to transact in a non-volatile token.
Secondly, the wallet experience for both the merchant and consumer was historically poor. For crypto payments to go mainstream, the experience must be better than the credit card experience. In the last 12 months, we have witnessed enormous funding rounds for crypto wallets, including USD380m funding for the hardware wallet Ledger and USD109m in funding for Phantom, a Solana wallet. On top of this, leading crypto exchanges such as FTX and Coinbase have been channeling resources into their own wallet software to make it easier for consumers to use for payments. A leading Asian player in the wallet space is Hi Dollars. This platform integrates with Whatsapp, making it seamless to send crypto over the messaging platform. In summary, the user experience around crypto wallets is rapidly improving.
Thirdly, there is a level of knowledge required to migrate from card payments to pure crypto payments. This is where crypto payment gateways have come in. Crypto payment gateways replace traditional payment gateways, although are themselves still acting as middlemen, handling crypto transactions on behalf of their users. Traditional payment gateways such as PayPal and Square (now renamed Block), have started accepting crypto and so are acting as a soft transition for merchants and users.
There are now numerous companies that offer crypto payment gateway services. Coinbase is one such company, allowing businesses to accept crypto for payments and invoice customers in crypto. Coinbase has been integrating with ecommerce solutions such as Shopify and Woo Commerce and charges a flat 1% transaction fee. BitPay is another company that acts as a crypto payment gateway. It offers free daily transactions of up to USD1,000 and free annual transactions of up to USD10,000, before charging a 1% transaction fee. While these crypto payment gateways are cheaper than their “TradFi” counterparts, they are still rent-seeking middlemen. There are purer solutions that are starting to appear allowing merchants and consumers to directly interact.
We have previously written about the architecture underpinning the Lightning Network and its recent surge of usage. It is a second layer on top of Bitcoin that allows anyone with an Internet connection to make instant, permissionless and nearly-free payments. Over the last 6 months, the Lightning Network has started to thrive particularly as a method for making very small micropayments online. For example, Fountain is a podcasting app that allows podcaster to earn bitcoin and receive messages from fans. Stacker News is another site that lets people earn BTC for sharing content that is valued by its community. In the real world, the Lightning Network is being used in El Salvador for daily purchases.
One issue with the Lightning Network today is that payments are made in bitcoin rather than stablecoins. Solana Pay is looking to address this by placing the stablecoin USDC front and center. On the 1st February 2022, Solana announced the release of Solana Pay, a payments protocol targeting digital commerce. Solana Pay has been built in collaboration with Circle, the company behind the USDC stablecoin. Circle will allow merchants to convert the USDC back into fiat USD so long as the merchant has an account with Circle. As a result of Solana’s high throughput, transactions will be instant and extremely cheap. Solana is in talks with several large ecommerce companies and Solana Pay could well be a tipping point that helps crypto payments go mainstream.
Over the last decade, crypto as a payment solution has faced a chicken-and-egg problem. Merchants need consumers capable of paying in crypto and consumers need merchants capable of receiving crypto. In 2022, both sides of this equation seem to be aligning. For merchants the economic incentive is clear, and the solutions are becoming easier to integrate. For consumers, crypto is reaching mainstream adoption and digital wallets are becoming easy to use and commonplace. In the coming years, we foresee it becoming unusual for payment providers not to offer crypto as a payment method. In the short term, middlemen payment processors like PayPal and Venmo will help onboard their clients into crypto. In the longer term, these middlemen will find it increasingly difficult to justify their fees as users realize that they can transact on a purely peer to peer basis.
It has taken over a decade, but Bitcoin’s vision for “A Peer-to-Peer Electronic Cash System” will be realised sooner rather than later.