Moving toward a cashless society with crypto payments
7 MINS READ
Industry
- Banking
Banking on purpose-led ecosystems
Highlights
- Cryptocurrency is fast becoming popular and many financial institutions such as remittances players and credit card networks are turning to the technology.
- Though traditional payments providers are reluctant to adopt crypto-based payments, they stand to benefit from the technology, as it not only has faster settlement cycles but also offers access to new customer segments.
- The concerns over the volatility of cryptocurrency are valid; however, banks and financial institutions must consider multi-rail, multi-instrument, and unified payment solutions when modernizing their payment infrastructure.
In this article
ABSTRACT
With consumers increasingly opting for new payment methods that are simple yet secure, cryptocurrencies are rapidly becoming popular across the globe.
Businesses have no choice but to adapt to this change and enable more options at the point of purchases. Several payment processors have also been quick to upgrade their systems to enable cryptocurrency transactions, allowing merchants to offer customers cryptocurrency payment options. Given the push from consumers as well as a robust response from several payment service providers, transaction volumes will only grow, and incumbent financial institutions may not be able to ignore this opportunity for long.
This point of view discusses the future likelihood of cryptocurrency payments becoming mainstream in the financial services industry and examines the benefits and concerns as well as typical use cases.
WHAT IS A CRYPTO AND HOW DOES IT WORK?
Cryptocurrency, when used as a form of payment, is essentially a value token or an instrument, which can be exchanged online for goods and services.
Blockchain, which is a decentralized technology, is the underlying technology of cryptocurrencies, and manages and records transactions across a network of computers. Cryptocurrency enthusiasts champion it for three main reasons: its potential to become the currency of the future, its ability to eliminate central intermediaries from the payment value chain, and the higher degree of security offered by blockchain compared with traditional payment systems.
A crypto payment service provider acts as an intermediary between the payer and the receiver for processing the crypto payments, allowing merchants to accept payments in cryptocurrencies both online and at physical locations. The service provider takes care of the complex backend workflow of crypto payments and offers buyers and sellers a seamless payment service.
THE CASE FOR INTRODUCING CRYPTO PAYMENT SERVICES
For many years, only digital innovators offered crypto payments, while established payment providers remained skeptical about the technology—for the major remittance players, cryptocurrency remained a marginal element at best.
But in the last 18 months, this has changed. The pandemic forced consumers to move all their transactions online and opt for contactless payment methods, in turn triggering an appetite for new, fast, and flexible digital payment methods. A survey by a leading card network reveals that most of the population will look at embracing at least one new payment method such as cryptocurrency, biometrics, contactless, or QR code in the next one year. A substantial proportion of people plan to use cryptocurrency payments next year while several people claimed to have tried a new payment option they would not have used in normal circumstances. The use of cryptocurrency payments for cross-border payments is also gaining ground, which has the potential to significantly disrupt the international remittances space. Moreover, cryptocurrency payment services have the capability to meet long-term goals such as enhancing the overall efficiency of payment systems and driving financial inclusion.
Recognizing that the tide is turning in the remittances space, some early movers have taken steps to add cryptocurrency payments to their portfolio of offerings. A leading US bank launched its crypto-based rail—one of the first bank-led, peer-to-peer (P2P) blockchain networks. On the other side of the fence, this rising demand for flexible payment options, including cryptocurrencies, is putting immense pressure on businesses to offer a multitude of new payment methods. Some major players have begun to accept payments in cryptocurrencies. Likewise, major card networks have announced plans to offer crypto payment options to customers, merchants, and businesses.
Volatility in crypto prices have led to the emergence of stable coins that are usually pegged to a dominant fiat currency. Use of stable coins has gained traction, especially in the business-to-business (B2B) segment, where the efficiency of blockchain-based payments and instant settlement can be delivered while managing the volatility. A leading card provider has launched B2B blockchain-driven payments facilitating faster and more efficient settlement cycles. Major players are attempting to create stable coin-based closed loop ecosystems—examples include Diem by Facebook along with other existing stable coins like USDC and Tether.
These developments have resulted in serious discussions and research at various central banks for issuing a central bank digital currency (CBDC). Several central banks have published discussion papers about the potential launch of their own versions of the digital currency. Most major central banks believe that CBDC will become a reality in this decade and there are various models of implementing CBDCs under discussion.
Use cases
Despite the skepticism and the reluctance of established payment providers to offer cryptocurrency payment services, there are several areas where crypto payments can be successfully adopted in the financial services industry (see Figure 1).
Figure 1: Crypto payment use cases
With increasing interest from both consumers and payment service providers, the number of transactions will expand but whether the volumes will rival established payment methods remains to be seen. The confirmation times for crypto payment using proof of work algorithms is still significantly low compared with existing traditional payment mechanisms. Using alternative algorithms and building overlay networks on top of base frameworks are being explored to solve these issues. In our view, blockchain technology in combination with other emerging technologies will significantly increase adoption of crypto payments in the coming years, as purpose-driven use cases mature.
Benefits of crypto payments
Compared with credit card payments, crypto payments have faster settlement cycles and can be cheaper due to lower transaction costs. Crypto payment services have the potential to build a borderless payment network with the ability to enable seamless transfer of crypto payments from anywhere across the globe. Crypto payment providers claim to maintain transparency in the highly dynamic exchange rates between the cryptocurrency and the fiat currency. Such services offer merchants different ways to accept global payments. In addition, merchants can also gain a reliable and authentic identity in the world of virtual payments—customers would hesitate to pay into an individual’s cryptocurrency wallet but an established payment service provider processing the payment would inspire a lot more trust and confidence.
Accepting crypto payments can help merchants access new customer segments. A considerable proportion of customers using cryptocurrencies are new to the merchant and the ticket size is double that of credit card users. In our view, crypto payments are poised to rapidly scale in the near future given their ability to lower cost of transaction processing, reduce the risk of fraud, and enhance transparency sought after by customers.
LOOK OUT FOR RISKS
While the case for embracing crypto payments is strong, a word of caution for those who see cryptocurrencies as the currency of the future: a currency needs stability so that institutions and consumers can determine a fair price for goods and services.
Cryptocurrencies, however, have been anything but stable through much of their history. This price volatility creates a conundrum—if cryptocurrencies are likely to significantly appreciate in the future, people are less likely to spend and circulate them today, making them less viable as a currency. Regulatory risks are also higher for existing versions of cryptocurrencies with many central banks opposed to the idea of alternatives to sovereign currencies. Tax implications are not clear for crypto-related transactions and continue to be a hurdle for adoption.
The payments segment has always been subject to regulatory oversight and the identity of the entity making payments has never been in question. But with crypto payments, the identity of the paying entity may not be clear, which makes incumbent banks wary of introducing this payment mechanism, especially given the prevailing regulatory ambiguity. Laws are still being framed globally on how crypto assets and payments must be treated from a regulatory and taxation standpoint. Consequently, most banks have adopted a cautious approach as they wait for a clearer regulatory framework.
In our view, banks and financial institutions embarking on payment infrastructure modernization programs must consider multi-rail, multi-instrument, and unified payment solutions and build the capability to enable crypto payments (see Figure 2). Financial institutions must take steps to introduce functionalities like crypto token issuance, crypto custody, and interfacing with crypto exchanges, along with aspects of crypto servicing and risk management.
Figure 2: Conceptual architecture of crypto payments
THE ROAD AHEAD
The overall increasing acceptance of cryptocurrencies is indicative of more global users willing to transact in them
Increasingly, a school of thought is emerging that cryptocurrencies are at an inflexion point: they are set to transition from being an asset class, which is bought, held, and/or sold, to a payment method that can support real-world transactions in the retail landscape. That said, incumbent financial institutions and leading payment providers are still mixed about cryptocurrency payments.
Technological advances and new offerings will continue to emerge. In our view, traditional payment service providers must grab this opportunity to create a win-win situation and introduce crypto payment services by leveraging their established brand names and trust built over decades. And sooner the better, for first movers will have the opportunity to lead by tapping into the profitability potential of a differentiated and disruptive offering.
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