Why the World's Payment Players are Accelerating Blockchain Based Payments
Why the World's Payment Players are Accelerating Blockchain Based Payments
Every day we read announcements from the world's leading payment companies that they are moving forward with blockchain based solutions in their ongoing strategies to make their payments faster, cheaper, and easier.
Why Are They Doing This?
In this week's newsletter we will take a close look and layer up the conversation, starting with traditional payment networks including MasterCard and Visa who are focused on lower cost and faster speed. Then showing how an unencumbered fintech, PayPal, can take the same blockchain technology to go even further by on-us netting (payments paid and received through the same entity) of entire payment flows. Finally, we will put it all together to show how China plans to use the same innovations to dramatically shift global trade settlement off the dollar based system that has lasted for the last 50 years since the world abandoned the gold standard.
MasterCard and Visa: Cheaper and Faster
In the West, MasterCard and Visa have become essential to the execution of the payments that a majority of us are involved in, most of the time. It wasn't always that way. In the past banks managed check based payment systems that required the physical movement of the paper in order to complete a transaction. Eventually we truncated the check (took the paper out of the payment), first in those cases where the payor and the payee were both customers of a single bank and then eventually allowing all checks to be truncated so that the payment became digital as soon as our check was signed, handed over, and entered into the banking system.
Unfortunately for checks, which were expensive to issue and process, slow to move, and easy to forge, scam, and steal, a better solution came with the re-invention of US payments in California at Bank of America, through a new innovation which was eventually spun off to become Visa.
This was networked digital payments on a common payment network where banks would agree to work together. In the US, two such networks became dominant - MasterCard and Visa, with American Express hanging on in there and most other players rolled up or displaced over time. Around the world there was massive consolidation although a few others continue to play important regional roles including China UnionPay and JCB.
The state of the art today is that most electronic payments for retail and commercial payments can be facilitated by one of the remaining payment networks - although they are costly, slow, and often unable to facilitate desired transactions, such as micropayments.
Let's focus on one issue: how costly are electronic payments? Well perhaps 2% of a transaction value - plus or minus - which does not sound like a lot to a retail customer. But consider a grocery chain like Safeway or Kroger. Their return on sales might be 1 to 3% whereas their return on assets maybe 3 to 6%. How do they get to that amount?
Buy products from food and hard good manufacturers all around the world
Ship goods through logistics networks to their warehouses and distribution centers
Ship to stores which they build, supply, and operate
Welcome customers who shop the shelves before arriving at the checkout with a trolley full of purchases
After the checkout operator adds it all up and packs it all, low and behold a new actor shows up and charges perhaps 50% of the retailer's return on sales just to facilitate the movement of money from the customer bank account to the grocer's bank account.
You get the picture. Payments, which are essentially digital movements of value, and which should be close to free, cost US grocery stores a very large percentage of their net profits every year, and the absolute $'s are going up, not down, at this moment in time.
Now the issue is not just how to lower costs. Faster speed can become very valuable for end users especially in a high interest rate environment where float (money moving in the payment system or stuck and not in use) earns the payment network a lot of interest, but not the end user who is missing out as their money lies around in other people's hands. Low speed settlement also increases counterparty risk which is not so relevant with MasterCard and Visa in domestic transactions, but certainly rears its head as a critical issue when slow international remittances are the focus of discussion.
So it behooves MasterCard and Visa to find cheaper, and faster, ways to facilitate their customer payments and this is why both have announced pilots to use third party stablecoins such as Circle on high volume, low cost protocols like Solana (we were early investors in both). Stablecoins can greatly reduce all aspects of the friction that the legacy networks of MasterCard and Visa still rely upon at the expense of their customers.
As Cuy Sheffield, the head of crypto at Visa puts it:
"At Visa, we’ve been on the forefront of payments technology for more than six decades. We saw the potential for the Internet in its early days and played a major role in helping it scale and support new forms of commerce. Today, we see significant potential for blockchain networks...While time will tell what role blockchain networks play in our world 10 years from now, if the fate of the early Internet’s critics can teach financial institutions anything, it’s that they would do well to have a strategy either way."
PayPal PYUSD: Beyond Cost and Speed to On:Us Netting
The problem with relying upon a third party stablecoin like Circle or Tether is that it cuts you out of the much larger opportunity that digital payments represent. This is not so much to reduce the cost or increase the speed of a transaction, but rather to eliminate the need for the transaction altogether. Specifically, this is the opportunity of on-us netting out the transaction.
PayPal has announced the launch of its own stablecoin, PYUSD. Initially this will be deployed within the PayPal ecosystem, which has tens of millions of users transacting with each other and the rest of the world as well. PYUSD will be able to travel everywhere PayPal users want their money to go. Let's focus on the use of a stablecoin within an ecosystem of tens of millions of users.
It goes without saying that the first big gains are associated with reducing the need for the PayPal transactions to flow through external payment networks such as MasterCard or Visa. PayPal can complete the trade within its own ecosystem if both payor and payee are PayPal customers. Reducing cost, and if digitally enabled with PYUSD, making the transaction essentially real time. These will be enormous consumer benefits for PayPal end users, and one would expect that PayPal would share back to them some of the efficiencies as they have done in the past.
However, this is really not the most important source of value creation and potential consumer benefit.
Consider that a few years ago, Facebook (now Meta) announced its Libra/Diem project to launch a Facebook stablecoin. The world rose up and killed the project very quickly. PayPal was an early partner of Facebook. While we don't know for sure, we assume PayPal saw straight away what we saw:
A stablecoin, issued by an intermediary that sits in the middle of vast numbers of payment transactions between tens of millions (billions?) of payors and payees allows for the opportunity to on-us net the transactions so that the money never needs to move at all.
"Financial payment netting is a process by which it is possible to consolidate and offset multiple transactions involving the same parties. Essentially, it involves the aggregation of various payments and obligations between counterparties to determine the net amount owed or payable. This reduces the number of individual transactions that need to be processed, thereby enhancing efficiency and reducing operational costs. In most payment ecosystems, netting is complicated because it requires multiple parties to agree - multilateral netting." (ChatGPT - we know :-) )
However, on-us netting is much simpler and this is what PYUSD will enable at PayPal. Simply put, if the buyer and the seller engaging in a transaction are both PayPal users, then PayPal has the option of netting out the transaction within the pool of millions of other similar transactions that may be taking place. Certainly, in this case there is no need for the transaction to leave PayPal and move over third party payment rails.
Conceptually, PayPal can just net off the credits and debits on their own blockchain based ledger...you can see where this is heading, and why Facebook (Meta) wanted to play this game themselves.
So this is a huge value driver for a payment focused company like PayPal. They have partnered with blockchain company Paxos to launch PYUSD, and right now all the media focus is on initial adoption. As always, initial adoption is not the point. This is about a five to ten year adoption cycle of a new, and groundbreaking, way to transform the payment system.
Actually, it should be a top three strategy for every payment company and probably for most banks, retailers, and everyone else who makes a living from moving money.
We expect it will be in the next year or two. The genie is now out of the bottle.
China: Dramatically Shift Global Trade Settlement
Now consider the case of China. Like PayPal, China has many trade partners with which it transacts all of the time. How would those transactions also benefit from digitalization?
As an example, China agrees to provide tens of billions of support for Brazil in the form of credits that Brazil will then use to buy products and services from China to level up its national infrastructure. Then China agrees to buy, and Brazil agrees to sell, billions in value of commodities that China needs. How will that be changed by the launch of a digital Renminbi/Yuan?
Well right now, China uses their national currencies (Renminbi/Yuan) and Brazil uses its own Real currency but for international remittances they rely upon old fashioned international remittance systems including SWIFT and correspondent banking networks.
Unfortunately for both China and Brazil in this example, most international payment systems are US dollar based. So in addition to the friction, especially in terms of cost and time, of moving the financial transaction from Renminbi/Yuan to USD to Real and back again, they, and especially China, face the risk of payment system delisting - or at least freezing - including in times of global strife.
So what would be a smart move for a country like China that is the world's largest exporter and represents about 15% of all global trade?
Well, do as PayPal is doing. Issue your own digital currency, with its own central ledger, and consider on-us netting of your international trade and remittances without the need to pass them out and through the US dollar based trade system.
Which means de-dollarization of Chinese trade globally where the US is not a counterparty.
Of course, that then raises the question, why wouldn't every other large economy do the same?
Why pay the cost of a dollar based international trade settlement system, if you can on-us net out your own payments with third parties who themselves may not want to pay the freight of using US dollars. Even if you can't net out some payments, at least you can digitally enable them and reduce cost and increase speed.
Conclusions
For us at Blockchain Coinvestors nothing that we have just written is new. We worked on check truncation solutions for Bank of America, Chemical Bank, and NationsBank in the early 1990's. We worked with MasterCard and VISA in the same timeframe on their international payments strategies. In the early part of this century we worked with PayPal on its digital wallet strategy, as we did with a host of others.
All of those strategy projects and experiences taught us a simple reality.
The state of today's monies, commodities, and assets is very clear if you look closely at them;
They are costly, slow, and not fit for purpose for a digital age;
So it is inevitable that we will digitize all of the world's monies, commodities, and assets and that will require an upgrade to all of the world's financial infrastructure.
Which is our investment thesis.
It is great to see the world's largest payment players accelerating the transition now. We hope that our own country's leadership will read this newsletter and ask themselves the question:
Should the US be a leader in innovating the world's global financial system?
We believe they have to answer that question with a resounding YES, and that is why the US government lawmaking and judicial systems are getting started in doing the right things. Passing pro-innovation, constructive regulation that makes sure that America is not the biggest loser as the world's payments become digitally enabled.
Thank you for reading.
The Blockchain Coinvestors Partners.
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Blockchain Coinvestors is the best way to invest in blockchain businesses. Our vision is that digital monies, commodities, and assets are inevitable and all of the world’s financial infrastructure must be upgraded. Our mission is to provide broad coverage of early stage blockchain investments and access to emerging blockchain unicorns. Blockchain Coinvestors’ investment strategies are now in their 10th year and are backed by 400+ investors globally. To date we have invested in 40+ pure play blockchain venture capital funds in the Americas, Asia, and Europe and in a combined portfolio of 750+ blockchain companies and projects including 75+ blockchain unicorns. Blockchain Coinvestors’ first fund of funds ranks in the top decile amongst all funds in its category on both Pitchbook and Preqin. Headquartered in San Francisco with a presence in London, New York, Grand Cayman, Zug and Zurich, the alternative investment management firm was co-founded by Alison Davis and Matthew Le Merle.
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