Bitcoin was established at the height of the financial crisis in 2009 as a way of creating a decentralized means of exchange that would be free from government interference. Users could use Bitcoin to purchase items and not worry about inflation or quantitative easing by central banks that could potentially devalue one’s savings. However, to make this a reality, Bitcoin must be valued in fiat currency and purchased for the first time in fiat. This means that the worlds of cryptocurrencies and fiat currencies will always be linked.
One of the main challenges for crypto adoption has been the difficulty for non-technical people to buy cryptocurrencies. A user that wants to buy a little Ether (ETH) would have to go to an exchange, send a wire transfer, buy the crypto and then leave then on exchange (with the exchange risk that comes with that). Not only is this process complex and involve many steps, but it takes a great deal of time.
Current Cryptoasset Buying Process
The reason for slow and inefficient methods of purchasing crypto largely has to do with the perception of risk. Big payment providers viewed crypto transactions as too risky and there was thus little appetite for them to partner with crypto based businesses. While it is true that Bitcoin was a hotbed of illicit activity 5 years ago with its pervasive use on websites such as Silk Road, things are changing. Many of the scams in the industry have faded along with the bull market. Regulation is catching up and authorities are beginning to take measures against alleged scams.
Due to this changing environment, major payment providers are now showing more interest in providing their services to crypto projects. Payment providers help facilitate the payments process by linking merchants to credit cards, as shown in the below diagram.
The Credit Card Value Chain
There are a number of areas where payment provider services can help reduce friction and increase the potential for widespread adoption.
The key area where payment providers can get involved now is exchanges. The payment process for exchanges is highly inefficient and means that many smaller retail investors have limited options if they want to purchase a cryptocurrency. A payment gateway would solve many of these issues. Not only would this enable credit card payments, it would also enable settlement in multiple currencies and potentially account to account transfers that bypass the aging and slow SWIFT system.
The first exchange payment integration was with Coinbase in 2015. Worldpay, the world’s largest payments provider, supplied a payment gateway that gave users the ability to buy cryptocurrencies with credit cards. Recently, both Binance and Kucoin have announced integrations with a small payments provider based in Israel that enables credit card payments for the first time. However, most exchanges still do not have a payment gateway integration, so there is considerable way to go for the industry to bring sleeker fiat based onramps into the market for the average user.
Protocols and DApps
At the moment the vast majority of projects with a native token do not sell their token directly to users. Rather, users must go to an exchange first, buy the coins and then transfer them directly to a personal wallet. This is even true for stablecoins, which cannot simply be traded for their fiat equivalent. Instead, the same exchange based process described earlier must be followed to obtain stablecoins.
Suppose there was another way. Suppose a retail investor or crypto user could go to the cryptocurrency’s website directly and buy with a credit card into a new wallet. This would give the user full ownership of the wallet’s private key and eliminate exchange risk. For example, a user could go directly to the website of the Ethereum Foundation and simple buy ETH using a credit card. A new wallet would be created for a first-time user automatically. The same process could be used by any DApp or protocol based projects. Payment gateways make this sort of solution possible. A payment gateway is friendly to new users and those that have limited technical skills, and would greatly enhance the prospects of cryptocurrencies gaining adoption.
There are a number of different ways to store cryptocurrencies off an exchange. The two ways to do this are via software and hardware wallets.. There is limited integration between wallets and payment providers. At the moment, users must buy cryptocurrencies externally via an exchange and send them to the wallet. There is no way they can buy different cryptocurrencies within the wallet itself. This holds true across wallets ranging from Exodus, My Etherwallet and the hardware Ledger wallet.
Point of Sale
At the point of sale (POS) there are also ways for payment providers to provide their services. There are many crypto based solutions at the point of sale. The competition is increasingly steep with many crypto based solutions entering the point of sale domain. PundiX & Salamantex are two examples. Generally, these services offer users the ability to pay for their purchase in cryptocurrency, either via a dedicated POS device or an app that can be installed on a mobile device. Integrating cryptocurrency payment solutions in retail shops or online is a great way for crypto projects to gain visibility. It also allows crypto holders a good and easy way to use their crypto holdings that would otherwise be languishing on an exchange or personal wallet.
There is also potential for payment solutions for non-fungible tokens (NFT). These tokens are used to represent unique items on the blockchain and can often represent ownership of a real-world item or a digital collectible. As is common with purchasing regular crypto assets, users are currently unable to use a credit card or standard gateway to buy NFTs. This is even the case if the NFT represents an investment (e.g. a share in a real-life piece of art) or an online collectible such as a crypto kitty. Instead users must buy with a fiat bank transfer that is expensive and slow. A credit card payment would allow near instant transfer of ownership.
The five areas above are the most important, but by no means the only areas where payment providers will have a presence in the new crypto economy. Currently, making a transaction in this area is slow, opaque, and costly. Payment services will help reduce friction and make crypto services more accessible to all.
This is the second part in a series about the way crypto card payments work. In future pieces we will explore the following topics:
- What determines where Sally’s payments can and cannot be processed worldwide and the currencies that the payment process supports?
- What is the difference between open and closed loop payment processing and what are the risks and benefits with using each?
- How and when are the payment processor fees charged?
- What role does the merchant of record play and how are they held to account?
- Who provides bankout/payout solutions?
- Who is held accountable for fraud protection and by whom?