The hurdles for a cryptocurrency in the race to merchant payment

Hurdle 1: Regulation

Of all the major payment crypto assets – Litecoin, Dash, Zcash, Monero et al – Bitcoin is the bloated competitor in the sprint to the point-of-sale (POS) with slow transaction times, relatively high fees and it burns through more energy than all the others in the race. Yet it continues to dominate the overall crypto market capitalization (53% compared to Ethereum’s 12%) and despite it being the oldest and clunkiest of candidates it is still the de facto official crypto and ubiquitous on exchanges, payment apps and could soon appear at POS terminals at Starbucks stores through NYSE’s Bakkt, a partnership between its parent company ICE, Starbucks and Microsoft.

Ari Paul, CIO of BlockTower Capital, estimates that bitcoin is owned by around 1% of the world’s population and even less than that actually transact in it for any purpose outside of speculation. The year-on-year growth rates of daily BTC transactions since 2013 have been negative so far in 2018

__Year-on-year growth of daily BTC transactions__

Year	% Growth
2013	83%
2014	102%
2015	178%
2016	102%
2017	61%
2018	-29%

Unsurprisingly, the price of bitcoin is still highly correlated with the volume of daily transactions, particularly since the end of 2017. This could be a difficult relationship to break because until price and transactions start to move in opposite directions, which card will a customer use at the checkout to pay for a coffee – the one that pays in a constantly devalued fiat currency or one that increases in value the more often you spend it?

The volume of daily bitcoin transactions has become highly correlated with its price.

Hurdle 2: SEPA and open banking

The Single Euro Payment Area (SEPA) is designed to make it possible for EU citizens to have just one bank account to span the entire continent, allowing customers to use a single card and bank account for transactions across any EU country. With a population of over 500m, more than the US, this an important market.

In 2016, within the EU there were around 60 billion total credit/debit card transactions – about 163 million transactions per day – with a value of 3 trillion Euro. Total non-cash payments in the EU topped 122 billion in 2016 and will only continue to rise as cash is phased out.

On a count of 200,000 daily bitcoin transactions per day (about the current rate), total annual bitcoin transactions would come to 73 million. Even if bitcoin was to take 10% market share of total EU credit/debit card transactions that would still require a 82-fold increase on its current network load, which it is currently incapable of handling even if it could attract that many customers.

Open banking and fast payment solutions

Governments around the world are making serious efforts to break up bank monopolies through ‘open banking’ schemes, particularly in the EU, UK and Australasia. Open banking is the universal term for a framework that allows the transfer of customer data between financial providers and technology companies through their APIs, with different iterations of it across the world.

The Australian bank industry is highly concentrated among the "big four" banks (National Australia Bank, Commonwealth Bank, Australia and New Zealand Bank and Westpac), which between them hold 80% of the home loan market in the country, with a similar situation among their New Zealand affiliates.

The process flow of Australia’s New Payments Platform.

Since 2014, the Australian government has been working with SWIFT to build its New Payments Platform (NPP) in an attempt to create a totally new financial framework for the country’s banks to allow for real-time clearing, posting and settlement, with the the Reserve Bank of Australia overseeing the settlement. Although not built on a blockchain, it is built in a similarly "layered" three-tier structure: basic infrastructure, overlay services and fast payments. Similar to a domestic Ripple network, financial institutions would adopt NPP standards at a fundamental layer with merchants and services built on top of it.

Apart from the US, other major countries are also well down the track with their move towards ‘real-time’ settlements. The UK’s Faster Payments Service has cut transfer delays between banks down from three days to a few seconds; Singapore’s G3 payments solution is another example.

*The state of national fast payment solutions across the world, as per the NPP whitepaper. *

Banks opening up their ledger books for real-time settlement through APIs is driving efficiency and user experience to a standard that will be difficult to match let alone surpass and it has also leveled the playing field for smaller startup disruptors. Australians are now able to send and verify transactions through SMS – the proposition of safely retaining a 12-phrase key and private and public keys plus all the 2 FA in between has already lost crypto the race for merchant and consumer adoption, at least in this heat.

SWIFT is contracted by the Australian government for the next 12 years and there’s not yet any obvious reason why Australian institutions would change.

Hurdle 3: SWIFT

Interbank blockchain solutions like R3 and Ripple are in direct competition with SWIFT (Society for Worldwide Interbank Financial Telecommunication) for international payments, and while they toil to convince investors, banks and consumers that their blockchain trumps the current transfer system they have even more catching up to do to with SWIFT as it rolls out SWIFT gpi, a GPS-like payment tracking system that all SWIFT members will gradually upgrade to.

*SWIFT, similar to an interbank version of Visa, is a network connecting 11,000 financial institutions in more than 200 countries.
*

Although based in Belgium, SWIFT has several US bank executives sitting on its board and because the interbank market is denominated in USD so are most of SWIFT’s transactions. This has led to a skewed US interest in SWIFT and some countries are seeking independence from the US/SWIFT network.

Germany and France have announced that they are working on their own international network which will extend to the rest of Europe to circumvent the US-imposed sanctions on high-export countries like Russia and Iran that the EU is dragged into through membership of SWIFT.

"I want Europe to be a sovereign continent not a vassal, and that means having totally independent financing instruments that do not today exist… If we want to build a truly independent instrument we must open up all the options." – French Finance Minister Bruno Le Maire

More countries are starting to oppose the USD monopoly on oil and commodities and a new system of international exchange is emerging. Alongside Venezuela’s Petro cryptocurrency, Iran this month will move to avoid US sanctions on oil exports by legitimizing and recognizing cryptocurrency mining as an official industry, with oversight from the Central Bank of Iran. Whether the country will issue its own crypto-rial is unclear but for the moment it appears Iran will power crypto mining with its build-up in oil inventories as a way to "liquidate" excess oil that it can’t sell on the market.

The USD status as global reserve currency has given it an exorbitant privilege for over 70 years now but, ideally, the next global reserve currency will not be tied solely to one country’s economic growth and productivity, many harking back to the age of the gold standard.

This is usually where we insert the cliche of Bitcoin as "digital gold" to the case in point, but XRP could make for a genuine country-agnostic currency that acts as a bridge between fiat currencies such as the Euro and Russian Ruble, without having to use USD as an intermediary.

Hurdle 4: Visa/card payments

There are around 13 billion payment cards worldwide, which in 2015 transacted $21.6 trillion globally. China’s UnionPay recently overtook Visa as the world’s largest form of card payments by transaction value and number of users and together with MasterCard, all three account for 89% of worldwide expenditure.

Visa already provides a cashless, touchless way of paying with Paywave technology and integrating that with the leading digital payment providers like Apple Pay and Google Pay customers can wave their iWatch or smartphone in front of a payment terminal. Currently, over 1 million merchants accept Visa via Apple Pay.

Visa is one of the largest businesses in the world with a brand value estimated around $145 billion. It has over 20,000 members, mainly banks and other financial services, and is used at over 20 million merchant locations by over a billion people. It will take some persuading to convert these people for whom transaction times and user experience aren’t an issue.

Visa’s decentralized model and ‘Security Token’ for IoT

In 1969, Visa was created with a very similar goal to governance-focused blockchains like EOS and Tezos. Namely, to break the monopoly of financial institutions; resolve the dichotomy of self-interest and greed that stifled progress in their industries and to move away from the old hierarchical style of governance to a more democratic one. It achieved an unlikely alliance between the major banks who were trying but unable to usher in a new financial innovation – credit cards.

Visa’s governance structure is surprisingly decentralized, unifying rivals together in a jointly-owned new business that adhered to a common governance structure, as set out by Visa, comparable to the governance foundations of blockchains like EOS, Hashgprah or Tezos. Transaction times aren’t a problem at the customer end which is ultimately where the drive and desire for a new currency is going to come from, so what could a Bitcoin Cash or Dash wallet do to improve the current experience on Visa’s?

Visa Ready is the company’s preparation program for the Internet of Things (IoT) by integrating its payWave and QR scanning technology with mobile devices – smartphones, smartwatches and Fitbits etc – across all operating systems and customers can already pay with a fingerprint and a swipe of a hand. More payment apps like Square’s Cash App now facilitate buying and selling of crypto through third-party exchanges which makes crypto more accessible and fungible for customers but its value proposition for merchants still remains unclear.

*Visa’s Security Token functions with Visa as a centralized encrypted token issuer. *

How about safety? If we believe encryption is the only solution to double-spending and compromised transactions then Visa provides a solution to that also with its Token Service, a unique encrypted number created for each transaction, which a user can authenticate by scanning their fingerprint on their device.

With the security token, Visa, similar to cryptos like IOTA, is positioning itself as a form of IoT payment between machines: cars would have a Visa payment app in the entertainment system and automatically pay for gas at a station, for example. Visa uses its own concept of "tokenization" to make IoT payments, taking an account number and tokenizing its associated card into a digital credential. It appears Visa is even embracing the crypto industry jargon ("token vault").

Unlike other incumbent market leaders – Kodak and Nokia – for example, that ignored a new technology until it was too late, Visa is clearly taking cryptocurrencies seriously and defending itself on all fronts. It is driving adoption of its IoT token worldwide through "token service providers" which are third-party businesses that connect token requestors (such as merchants holding the card credentials) to the token platform – Visa Token Service. TSPs also perform token-related tasks on behalf of issuers.

How the Visa token would operate between machines in an internet of things payment.

For most of its existence, until Visa went public in 2008, the members were the only owners and there were no shareholders.

Visa is arguably more centralized since it has become beholden to shareholders and, along with Mastercard, it has often fallen foul of customers and companies over high fees and been brought to court over antitrust concerns, most notably a 1996 class action brought by 4 million plaintiffs, including Walmart, which cost the company around $2 billion in fines.

It could take generations to fully embrace the seeming chaos of an organization that no one “runs” and as Visa’s creator, Dee Hock, has conceded, “we at best got it only half right” – maybe a DAO could take it the rest of the way?

Hurdle 5: Big tech (Apple Pay, Samsung Pay)

Presuming a Bitcoin, Litecoin or Dash can win the hearts of regulators, merchants and consumers, they will next to have to overcome big tech’s native payment solutions: Apple Pay, Fitbit Pay, Samsung Pay and, in the east, China’s WeChat and AliPay that are already deeply ensconced in the P2P and merchant payments space.

In China, WeChat’s mobile payments platform already accounts for half of the world’s global mobile payments. In 2017, AliPay and WeChat processed more value in online payments in one month than Paypal transacted in the entire year. Given the close cooperation between all Chinese mega companies and the Chinese government, WeChat and AliPay’s parent companies Tencent and Alibaba will toe the communist party line and continue to forbid crypto trading or payments on their apps while the People’s Republic of China installs its own digital currency – this also provides a convenient protective moat around their own payment platforms.

Nonetheless, investment is flowing into fintech companies many of which are blockchain/crypto related and 2018 is set to be a record year.

Source: CB Insights Global Fintech Report Q2 2018

Apple co-founder Steve Wozniak, a loud and proud bitcoin believer, is also reported to have joined the controversial crypto-fundraising startup Equi Capital.

Source: CB Insights Global Fintech Report Q2 2018

Although investment in blockchain companies is growing unabated it is focused on the infrastructure space, as opposed to cryptocurrency projects themselves, as evidenced by the loss of momentum in the ICO market.

Source: CB Insights Global Fintech Report Q2 2018

Apple Pay now has an estimated 250,000 users and the number of accumulative transactions exceeds 1 billion, with 4900 banks now supporting the on-boarding of clientele onto Apple Pay worldwide. Another massive head start Apple and Google’s Android has on cryptos and their associated wallets is that they can be pre-installed on all the mobile phones in the world, making them a default option and without the need to remember 12 phrase keys or passwords generated by Google Authenticator.

Hurdle 6: Digital banks

Technology is renowned as the land of unicorns and among its green pastures, fintech startups, continue to grow in population. According to CB Insights, there are 29 fintech unicorns globally valued at around $84 billion and Q2 2018 alone saw the birth of five of them, including the crypto payment app Circle.

Digital banks/payment companies have reached billion dollar values seemingly overnight, many without even having a global presence: Square, Stripe, Adyen, Revolut, Monzo, Twilio and Worldpay are only some of the newly-minted billionaire dollar companies in the industry but there are hundreds of similar smaller companies valued in the multi-millions.

Digital banks/Fintech target cryptos ideal customer: Emerging markets

VC lending in Asia has been on a sharp rise and India has seen a surge in VC early stage tech investing, targeting small and medium-sized businesses in emerging markets. In Q2 of this year alone, $16.07b was pumped into Asian fintech companies through VC-backed equity funding, compared to just $3.2b invested into US fintech.

Most of the Asian fintechs being invested in are focused on merchant and individual credit/lending, wealth tech and payments. VC investing in blockchain fintechs also hit a 5-quarter high in Q2, up from $179m in Q1 to $633m.

2018 may also be the year of the long-heralded “Bank of Amazon” finally coming to fruition with the company targeting merchant growth in India and Mexico in particular and investing in several digital banking startups in both countries. In Mexico, Amazon has a cash payment service that is an alternative to a credit or debit card. In the US, it is unlikely Amazon will try to take the retail banks head-on but there is still concern among them of their disruptive potential to combine big data, ecommerce and AI with financial services.

Most digital banks and payment apps propose very similar functions to each other and appeal in the same way to a millennial generation that a crypto wallet does: cheap/free global transactions and more control of their finances outside of the “system”. These startups are more nimble utilizing customer data made available to them through open banking APIs, than the retail banks are themselves, and excel at UI with customized features and visualizations for budgeting and forecasting.

Most digital banks allow customers to hold funds in multiple currencies and freely exchange between them, making transfers free and almost instant. Digital banks exist only as an app and don’t offer savings accounts with interest rates that regular banks do though they do issue some version of a Visa and Mastercard.

Fintech is benefiting from crypto products

Adding to their appeal, many payment apps and digital banks have added crypto products to their platforms and subsequently seen a surge in their user numbers.

Source: CB Insights Global Fintech Report Q2 2018

The digital bank Revolut and trading platform Robinhood added 1 million customers each since they added crypto payments to their apps and social trading platform EToro has tripled its customer base since it introduced cryptocurrency trading. This could also be due to these platforms offering 0% fee transactions. According to financial services giant Charles Schwab, over 50% of US millennials and Gen-Xers would switch brokerages to trade commission-free.

Commission free-trading and discounts on trading fees has become a huge driver for many crypto exchanges growing at explosives rates – particularly in the volumes of Asian exchanges.

Alibaba’s Ant Financial worth more than Goldman Sachs
Alibaba’s Ant Financial Group, formerly known as AliPay, has also grown into a global financial powerhouse – among the top 10 banks globally. Although not publicly listed, Ant Financial is valued at $150 billion, far more than Goldman Sachs’ $88b valuation. According to CB Insights, its private investment in Q2 2018 accounted for almost 70% of global fintech investment.

Chinese tech companies are ring-fenced from non-Chinese competition by the government’s protectionist policy that has kept international giants like Facebook and Google out of the country. A similarly strict anti-crypto policy has been enforced in China that has seen all access to domestic and overseas crypto exchanges cut off, crypto payment apps removed from app stores and even going as far as to ban all blockchain and crypto-related events in the country.

Getting a crypto wallet, let alone a point of sale service, active in China will be a very long game.

The Lightning Network at point-of-sale

Without a natural demand for bitcoin it will continue to be accumulated and sold purely for speculating and hedging and the price of BTC may continue making lower highs – merchant adoption is key for this natural demand.

Although details are still scant, Bakkt could make use of the Bitcoin Lightning Network as a form of BTC payment in a Starbucks store, using for transactions under $50 dollars, which is the max value for LN to be fast and almost free. Coffee is always cited as an example of the kind of “microtransaction” the LN was built for and the Starbucks coffee app is one of the most downloaded payment apps in the US, so it’s a natural testground.

The Starblocks test site for a Lightning Network coffee payments.

To simulate Lightning payments for merchants and customers and how it might function in a real Starbucks store, download the Eclair Lightning Network testnet wallet on Google Play and to that address download free testnet bitcoins from a faucet. To learn how the wallet and Lightning Network works take them for a spin at the Starblocks website, a mock online coffee that supports bitcoin.

The LN’s rebalancing roadblock for merchants

LN payments under $50 will be largely free and instant, however, at the moment there remains one roadblock for merchant adoption – channel rebalancing.

Participants in the LN (merchants and customers in this case) must have enough funds in both their inbound and outbound payment channels to ensure a user has a sufficient amount in their channels that they want to receive or send. As there is a total funding limit for every channel and as they cannot be "topped up" the channels must be constantly "rebalanced". This means if A (0 BTC) opens a channel with B (2 BTC), where A spent all their BTC on transactions with B, user A’s send channel can be rebalanced by B so both have 1 BTC each and A can spend again.

While still in beta testing, routing of transactions is still another issue to overcome for merchant adoption. Simulations for LN micro payments show that among nodes with at least one channel big enough to route a coffee, the probability of the transaction finding a route is around 70%.

The probability for a successful payment between two random nodes on the LN with sufficient funds for a coffee.

From this chart, 70% is the maximum probability of a ~$3 coffee transaction (0.0004 BTC) being successful but if one were to stretch the order to ~$7 (0.01BTC), the probability would drop to 10%. The only 100% guaranteed transaction would be worth $0.26c.

Auto-rebalancing is in the pipeline but for the moment rebalancing a channel would require a merchant to track the balance and "manually" rebalance, potentially several times a day.

Emerging markets remain greatest use case

Still, sparks of innovation are flying around the industry that could catch fire in any country.

Fintech venture capital investing in Asia has ramped up in recent years; it is well above that in Europe and in Q2 2018 it almost equaled North American VC investing. US bitcoin payment app Bitpay has seen big success in Asia-Pacific for cross border payments, processing over $1 billion in BTC transactions in 2017. It is also working with Korean exchange Bithumb on a B2B cross-border payment solution for larger transactions while slashing fees using bitcoin.

In Venezuela, Dash has seen a significant increase in wallet downloads and merchants have been signing up at a rate of 200 a month, according to Dash CEO Ryan Taylor. Retailers such as Calvin Klein and Subway are among those that have signed up to accept Dash and it has partnered with Kripto Mobile Corporation to roll out so-called KRIP phones with preloaded Dash wallets at a rate of 10,000 units of the phone will be rolled out to consumers every month, which will complement the 1,000 merchants already accepting Dash in the country.

Dash also saw a 30% surge in its price on news of Venezuelan adoption, as it partnered with Kripto Mobile Corporation to roll out so-called KRIP phones with preloaded Dash wallets at a rate of 10,000 phones every month, which will complement the 1,000 merchants already accepting Dash in the country.

Other US payment apps Circle and Square will also been big drivers of merchant adoption of crypto, with Square’s Cash App being touted by Wall Street analysts having huge potential for the underbanked populations in emerging markets. Last week, Square also won a patent for adding multiple cryptos as forms of payment to its app.

The most likely scenario at this point is that we will a crypto emerging as an option for merchant payments across different countries and another one for international trade, though the race is far from a foregone conclusion.

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