This is Part 2/chapter 3 in The Blockchain Economy book. This serialised book is a practical guidebook for investors, entrepreneurs and employees who want to learn how to prosper during the transition to an economy where value exchange is permissionless and disintermediated. For the index please go here.
Payments has been the boulevard of broken dreams.
Payments gets entrepreneurs and investors salivating because it is a huge market. According to Boston Consulting Group:
“In 2013, payments businesses generated $425 billion in transaction revenues, $336 billion in account-related revenues, and $248 billion in net interest income and penalty fees related to credit cards. The total represented roughly one-quarter of all banking revenues globally. Banks handled $410 trillion in noncash transactions in 2013, more than five times the amount of global GDP.”
Yet dreams of disrupting the current payment rails always seem to get dashed against the rocks of reality. A quick glance at the stock price of Visa and Mastercard tells us that the market does not buy any disruption story to the credit card rails. Nor do SWIFT revenues seem impacted yet by Ripple. Micropayments remains a technological pipe dream beyond a few early adopters.
Ventures that play within the credit card rails, by making it easier for merchants to accept Credit Card payments, do well enough but there are stories of merchants simply getting Basis Point reductions by playing off one against the other. That sounds like a commodity race to the bottom, not a recipe for Unicorn status.
Eeyore feels justified in saying “I told you so” and Tigger is seen looking rather sheepish (which is unnatural for a tiger).
Today Bitcoin is totally broken as a payment rail for small transactions – slow and expensive. This chapter suggests a contrarian thesis that Blockchain based payment rails will finally disrupt the payments business from micropayments to wire transfers by describing how:
- Cryptocurrencies can address the biggest issues in credit card payments.
- Two variants of payments will coexist, secret and open.
- Where in the range from $0.01 to $100m payments will disruption hit first.
- Layer Two networks could bring scale, speed and low cost to cryptocurrency payments.
- We should be looking at the Rest not the West for this disruption.
Cryptocurrencies can address the three big issues in credit card payments
We focus on credit card payments first, because this is the gorilla. It is huge and has been totally resistant to change. Once this dam breaks,change will flow to all the other price points.
The three big issues for consumers and merchants using credit cards are:
- cross border payments cost too much for consumer. This is a cash cow for banks because consumers who travel or buy cross border have no real option and merchants don’t care because they get paid in local currency.
- fraud can destroy a small-business owner. If they accept payment from a stolen credit card they will a) not get paid for the product they sold b) banks may look for reimbursement for permitting the fraudulent transaction and c) payment processors may terminate their account and put them on a blacklist.
- Small transactions either require credit card fees (which can kill their margin) or the pain of handling physical cash.
Credit card networks have won by isolating the problems between consumers and merchant. The change will come from small business merchants, because they are most affected and will happen initially between small business merchants as they understand both sides of the issue. That is where Square could drive change.
Two variants of payments will coexist, secret and open
Cash is amoral. Cash does not care what you do with it. You can buy legal drugs or illegal drugs. You can use it to kill somebody or save somebody’s life.
The same will be true for digital cash. Some darknet aka illegal transactions will move to currencies that specifically cater to this niche and some may get done using bitcoin in ways that protect secrecy (just like cash does today).
Where in the range from $0.01 to $100m payments will disruption hit first?
The least likely to feel disruption will be the high end. If you have laboured for months on a deal, will you now take a risk on a new payment rail when that $100m needs to get sent?
Our thesis is that innovation will happen first at the intersection between what are now fairly distinct payment rails, such as:
- the high end of micropayment and the low end of Debit & Prepaid.
- the high end of Debit & Prepaid and and the low end of Credit Cards.
- the high end of Credit Cards and the and the low end of Wire Transfer.
What makes Blockchain, with Lightning Networks, so disruptive is that it can play across all these categories.
More innovation is coming. The prize is big and entrepreneurs are ingenious. For example, expect innovation around Stablecoins as interim stores of value in payment rails.
Layer Two networks could bring scale, speed and low cost to cryptocurrency payments.
Layer Two networks such asLightning and Raiden Network will enable:
- Human real time transactions (within seconds). Consumers see no reason why payments should take longer than messages and Facebook updates.
- Borderless payment. Location will be as irrelevant as it is in messaging and social media.
- Micropayment transactions (even below what is possible via credit card networks).
- Greater scale than credit card networks today – millions or even billions of transactions per second. This is like moving from Post Offices (big enough) to email (so big that everything changes).
- Permissionless. Anybody can set up a Lightning Network node and transact “offchain” or can choose to become a Bitcoin Miner and transact “onchain”.
This will change human behaviour and enable a whole range of new applications.
As I write (February 2018), Lightning Network is being tested. So we read stories of transactions getting messed up. You can take two points of view on this:
- These messed up transactions prove that all the talk of Lightning Network was simply hype.
- That is why we test new technology. We expect to find bugs when we test. Those bugs will get fixed.
We will soon know which one is true. I am making my bet on 2. There are persuasive arguments for 1, but when you read these bear in mind that there is a lot of money at stake as Altcoins battle to take over the pole position from Bitcoin and as incumbents fight the narrative that the current payment rails will be disrupted.
2017 was the year that Bitcoin became an asset (one leg of the stool) and 2018 is the year when the other leg (means of exchange) gets built onto the Bitcoin stool.
We should be looking at the Rest not the West for this disruption.
Most people are looking in the wrong place for this disruption – it may happen first among the “next billion” consumers entering the global middle class from the Rest of the World, from places such as China, India and Africa.. In those countries, most employment is in the small businesses who are most motivated to take bitcoin because the 3 big problems described above are an existential risk for them.
Bernard Lunn is the CEO of Daily Fintech and author of The Blockchain Economy. He provides advisory services to companies involved with Fintech (reach out to julia at daily fintech dot com to discuss his services).