Paving the Road to Crypto Commerce: The Intersection of Traditional Payments with Digital Currencies

As the blockchain industry accelerates at a breakneck speed, enthusiasts tout cryptocurrencies as instruments of payment that are faster, cheaper and easier for users to buy goods and services in the digital world. However, there continues to be major pain points around user adoption and customer experience in addition to layers of friction when acquiring and utilizing cryptocurrencies. The most critical pain point is how to bring fiat currencies (government issued legal tender such as USD) into the digital space.

2019 has quickly become the year of payments. We now see an arms race between exchanges trying to address the critical issues of fiat on-boarding and the integration of credit and debit card payments. It is therefore important to better understand how traditional payment gateways and the new world of crypto commerce intersect, and how this convergence will drive user adoption.

We thought it would be helpful to provide some context around what actually happens behind the scenes when a card purchase is made. The different parties that are involved throughout the value chain and how this can ultimately impact the quality and pricing of card payment services for the end-customer.

Buying Ether with a Card on Xchange1

Let’s look, specifically, at how card payments work when crypto exchanges have been successfully integrated with a card payment option for customers. For this exercise, let’s assume that a customer, Sally, has already set up her account on Xchange1 (our favorite hypothetical crypto exchange platform). To do this, she has to have passed a set of Know Your Client (KYC) / Anti-Money Laundering (AML) steps, which involve checking her identity with a valid form of identification. After the check has completed, she receives a notification and is ready to buy her first Ether (ETH)! To do this, she has just linked one of her cards with her newly activated Xchange1 account. At today’s exchange rate, one Ether will cost her 136.30 USD. She is now ready to make her purchase.

Card to Crypto Purchase

Let’s take a closer look at what happens next. There are six main participants in this scenario:

  • Sally — Crypto Trader
  • Xchange1
  • Acquiring Bank
  • Payment Processor
  • Sally’s Card Network
  • Issuing Bank

Step 1: Transaction Authorization & Authentication:

The merchant, in this case Xchange1, gets the price of ETH. Xchange1 then sends details of the transaction through to the acquiring bank. The acquiring bank sends a request for authorization on to Sally’s card network, which in turn requests authorization from the issuing bank. Assuming there are no issues with Sally’s card and that she has the funds available, the issuing bank provides an authorization code, which is passed through to the acquiring bank and finally on to the merchant, Xchange1. Luckily, all of this is completed within seconds, or Sally would lose patience.

Step 2: Batching Transactions:

Xchange1 doesn’t actually receive any money from Sally in step 1. Xchange1 waits until the end of the day when it sends the day’s list of transactions to its acquiring bank, which then reaches out to the relevant card networks for payment for the day’s transactions from all of Xchange1’s customers, including Sally. Those card networks must then reach out to the relevant issuing banks for each of those customer transactions to request payment.

Step 3: Funding and Clearing the Transactions:

Finally the money begins to change hands. The issuing bank has received the request for money from the acquiring bank via the card network and the money is sent through the card network less interchange and assessment fees. Once the acquiring bank has received Sally’s money minus fees, the clearing process is completed. Before Sally’s payment is deposited into the exchange’s account, however, the acquiring bank takes another fee called a ‘discount fee’. Finally the exchange is paid.

Fees

There are three main fees levied against the exchange, which together make up the discount fee and are a percentage of the transaction paid for just accepting payments from cards.

  1. Interchange fee: set by the card networks (market based) and influenced by several factors
  2. Assessment fee: card brand fee that card processors pay the card brands
  3. Markups: typically comprises a lower proportion of the overall discount fee charged to the exchange

International Transactions

The payments ecosystem is highly fragmented globally. While major card network brands like Visa & Mastercard have a definitive global presence, many countries still have smaller networks which dominate the local market. For example, what if Sally lives in the Netherlands where iDEAL holds over 50% of the market, how does she process a transaction with Xchange1? Sally will either, be denied the ability to process via card or she has to pay with a different type of card, if she even has one. Alternatively, Xchange1 can use a global acquirer that is connected to an exhaustive list of card networks around the world so that Xchange1 can easily and efficiently service its global client base.

Chargebacks

What if Sally forgets about the ether she purchased using her card and decides to dispute the charge? Her complaint will go to the issuing bank, which will then issue the exchange a penalty. Should the exchange not respond to the issuing bank’s ‘retrieval request’, the exchange will be penalized further. If Sally wins her dispute, the issuing bank will be able to recover the full cost of Sally’s payment for her Ether.

On-ramp to Greater Adoption of Crypto

Crypto is gaining wider appeal for its potential as a way for end users like Sally to participate in new digital economies. However, it is still difficult for the Sallys of the world to purchase crypto on exchanges and take part in these new token platforms. By introducing a fiat on-ramp that enables card purchases, the exchanges can remove part of the friction that exists in the process of purchasing crypto. This will lead to greater adoption of crypto and help spread access to innovative platforms.

This is the first 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?

If you’re interested in learning more about cards to crypto, please contact us at payments@bcw.group.

If you’re interested in learning about BCW’s research, please contact research@bcw.group.

BCW Group is a global strategy and management consulting firm with a variety of high-profile corporate clients focused on making blockchain use cases come to life. We work as an integrated partner with global payment and technology infrastructure firms to rapidly advance the blockchain industry ecosystem.