Lessons from Fiat: The Crypto Payments Industry and the Race to Volume

Judging by how most people talk about crypto, you’d be forgiven for forgetting the ‘currency’ half of the word. Tokens from ETH to SOL are bought for investment, savings, speculation, flipping, trading, borrowing, lending and more. Anything, that is, other than spending. And this doesn’t come down to design flaws. Indeed, many cryptocurrencies, particularly dollar-pegged stablecoins, have money’s full triad of features by design.

Why then, am I yet to see a customer in an Apple or a 7/11 store swiping their card and spending their cryptocurrency as a medium of exchange?

And no, it’s not for lack of 7/11’s interest either. Merchants, for their part, also benefit from accepting crypto payments. Removing intermediaries promises lower fees, instant settlement, and, therefore, instant cashflow. It also provides live traceability of funds which optimises accounting and supply chain management processes.

Accepting crypto and settling in fiat also has its benefits. Merchants are always looking to expand their customer pool, and ideally into those with deeper pockets. The benefits are the same as point-of-sale products like buy-now-pay-later (BNPL), or expensive schemes like American Express membership, in that by enabling crypto purchases crypto-native users will be encouraged to choose a specific store over other exclusively fiat-based stores. And in the next bull cycle, maybe they’ll even come with deeper pockets too.

Combined, these factors mean up to 60% of merchants are primed to accept crypto.

Why then, are only 4% of merchants currently offering crypto payments options?

Well, I’ll give you the short answer. Despite theoretical promises, paying in crypto is in fact neither cheap, nor efficient.

• Almost all of the payments industry’s business models, from processors to exchanges to payment rails, boil down to fee(s) on volume. And volume is difficult to secure, especially in an open-source industry like crypto with fickle consumers, volatile prices, and liquidity providers that seemingly collapse every two weeks. This means the market is full of small and fragile players fragmenting liquidity and stumbling to their revenue-generating feet.
• Volume is also the most desirable moat. Enough volume, as seen with the behemoth incumbents in the fiat payments tech stack, gives 1) negotiation power to lower fees with partners, and 2) enables new and potentially bigger revenue streams that come with the insights from aggregated transaction data.

So, given this, who will win out here and how?

Part 1: The Anatomy of the Swipe

Let’s consider how information and funds flow between the existing tech stacks behind fiat and crypto payment rails.

Fiat Payments

Flow of Funds and Information in the Fiat Payments System

There are numerous resources that explain the mechanics of how this works. I would recommend starting with Stripe’s article, Siddiqui’s book on card payments, and lastly this Global Payments primer by Glenbrook if you want to dive deeper.

For now, all that’s important from the above diagram is to realise that, firstly, the actual fund settlement is often T+1 or even T+2 depending on the speed of the native bank clearing system, and, secondly, the business models of all of these parts are simply fees on transaction volume. Combined, when you swipe your card, the merchant is charged the following fees:

• Processor fees (1.3–3.5%)- charged by processors for connecting to card schemes. Optimising processing fees requires high volumes and low merchant risk through a strong AML/CTF program
• Interchange fees (1.1–3.3% + $0.1)- charged by issuing banks, optimised by incorporating as local merchants in different regions to not require cross-border interchange rates
• Scheme fees (1.3–3.5% + $0.1)- charged by card schemes for processing the transaction on their rails
• Exchange fees (1–3%)- charged by issuing banks if currency conversion required
• Chargebacks (5–10% or $20–100)- charged by acquiring banks if customer disputes a transaction or if there is a fraud attempt

Now, what about if the customer wants to pay in, say, Bitcoin?

Crypto Payments

The original promise of Bitcoin and blockchain technology was the possibility of peer-to-peer transactions, making it possible to send crypto from one wallet to another without any of the above intermediaries, and at significantly faster settlement times (speed depending on block finality time of the chain).

However, in reality, this is more suitable for individuals paying one another, and a customer-to-merchant relationship requires its own infrastructure stack to formalise this at any level of scale. This falls into two types of offerings analogous to those in the fiat system: card issuers (consumer facing), and payment service providers (merchant facing).

Flow of Funds and Information in the Crypto Payments System

Card issuer/processors are responsible for KYCing the customer, and then act as a pseudo-issuer bank on behalf of the customer’s wallet which allows them to connect directly with the card scheme. Visa and Mastercard have both publicly recognised the potential of faster settlements, and established their own crypto card membership schemes to connect with their network of 80m and 30m merchants respectively. Within these schemes, they work with stablecoin partners such as Circle and Paxos to enable stablecoin settlement. This means that if the merchant wants to accept cryptocurrency, the settlement would be instant into their chosen wallet. If the merchant only wants to accept fiat, then the crypto would be exchanged to stablecoins and then into the respective fiat currency, before travelling along the usual rails to the merchant’s acquirer bank.

If the merchant wanted to regularly accept cryptocurrencies, it could also integrate a crypto-specific payment service provider (PSP), which, analogous to Stripe, would act as a pseudo-acquirer bank and handle both the KYC and fraud management, and the currency settlement. The merchant would then have their own dashboard overview and management system, tracing customer data and the movement and balance of funds.

So with crypto payments, although some of the fiat intermediaries (and therefore fees) are removed, we are left with the following additional fees to consider:

• Exchange fees (1–5%) set by the exchanges and market makers. When charged by centralised entities, these can be negotiated but again will mostly be optimised with higher promised volume. DEX exchange fees are determined by relative liquidity.
• An additional gas or network fee ($0.00025 on Solana — $0.01 on Ethereum L2s) to reward the nodes who secure and validate the network. Whether this supersedes the fiat fees depends on the chain, the complexity of the transaction and a number of largely uncontrollable variables including demand for blockspace, i.e. network congestion. But this fee is fixed rather than proportionate, meaning payments companies that aggregate transactions effectively can significantly save on this fee, but makes micropayments particularly difficult on Layer 1s like Ethereum.

The payments industry — both in fiat and in crypto — is comprised of fees on payment volume. Crypto start-ups looking to disrupt the industry by offering lower fees to merchants than extractive incumbents will need to find ways to secure enough volume to negotiate their rates down or bypass existing component players in the stack entirely.

Part 2: The Volume Game

Now, because transaction volume is the main chip that merchants and payments businesses use to negotiate for lower fees, they often face a catch-22:

Most customers choose the lowest fees; the lowest fees are ensured by the most customers.

Crypto companies have the hindsight of two key lessons from the fiat payments industry that can be applied to drive greater volume.

1. Go-to-Market: Improving Customer Acquisition and Engagement

To break the catch-22, start-ups need to find a way to secure initial volume when fees are at their highest. Fortunately, in the payments space, there are a myriad of tangential offerings which can hook a merchant and help them swallow the fees.

For payments service providers:

1. Customer insights: On-chain data can be leveraged to better understand a customer and their other spending and financial behaviour, which is useful feedback both in aggregate and individually in real-time for product, data, and marketing teams. This could come with an associated analytical engine and dashboard, particularly if wallets began to include verifiable credentials and social data that enable them to better understand consumption patterns. Oamo (WSC portfolio company), for example, is an opt-in consumer data marketplace which could power this. On the other hand, access to a wallet’s previous activity could improve a KYC provider’s ability to assess the fraudulent or illicit nature of a customer and reduce the $117bn yearly costs of chargebacks without introducing additional friction or losses for the user. We’re seeing increasing numbers of players offering transaction monitoring and risk assessment solutions, and the best of these ingest both on-chain and off-chain data. VaaS, for example, is a Brazilian risk assessment solution for Brazilian fintechs, combining data from the Pix payment network, blockchain transactions, and local data bureaus like credit-scoring bodies to get the most holistic and real-time view of customer profiles for institutions providing financial products.
2. Customer engagement: Relatedly, crypto payments businesses that catch the consumer at point of sale can also offer improved customer engagement and loyalty programs. Being able to prove loyalty and early adoption could feed into a membership and rewards scheme, like the SaaS solutions built out by TYB and Kalder. Because it can be up to 25x more expensive to acquire a new customer than to keep an existing one, and because consumers spend more on brands to which they are loyal, a 5% increase in customer retention can correlate with up to 25% profit increases. This strategy is most effective for smaller D2C brands who rely on branding and customer loyalty. Companies experimenting with this tend to be exploring one of two models: a mutable NFT tracking user activity that enables exclusive access to other products, or tokenised rewards airdropped to the most loyal customers. Consider this the hyper tech-enabled version of Amex’s air miles.
3. Credit decisioning: For any merchant wishing to experiment with point-of-sale credit, the added insights of a consumer’s on-chain activity could add colour to their assessment of fraud and credit-worthiness. This is most exciting for the 1.7bn unbanked population who cannot access traditional lending institutions or build a credit file. DeLend, for example, is looking to build a Maple Finance (an on-chain institutional capital marketplace) but for buy-now-pay-later for Latin American retail merchants. Not only is this a novel approach to sourcing the credit supply, but it also can feed on-chain data into its credit-scoring engine to make the customer profile more comprehensive.

These standalone verticals are all competitive and hard to differentiate. As a start-up dedicated to one of these, the individual offering needs to provably result in an active increase in revenue (whether that’s through increasing the customer pool size, basket value, retention, or conversion rates) or decrease in cost (whether that’s through tax optimisation, or native reward schemes cheaper than monetary discounts). In reality, the difference is usually marginal if not nought, often leaving these products as a ‘nice to have’ rather than a stickier and higher ACV ‘must-have’. As a payment service provider, however, a start-up can integrate some of these associated perks to convince merchants to on-board, and either absorb the cost internally or use it to tier pricing models for the core payment rails products.

For card issuers:

1. On-ramping to upsell: Since card issuers are customer-facing, the additional perks to consumers will have to come in the form of an in-app experience. This could either be a standalone wallet or an SDK for existing wallets, from which users could onboard with educational content before on-ramping or experimenting with new crypto products. We’re seeing start-ups like Relay experiment with AI for this onboarding piece, enabled by the open-source nature of crypto and publicly available Github depositories and white papers that AI bots can distil for users. The possible future extension of this is AI agents trading customer crypto funds sitting in wallets, particularly as this is synergistic with the market makers and DEX/CEXs responsible for the crypto exchange in the backend. Binance Card, for example, has an ideal go-to-market as customers already have a wallet, through which they can buy and trade more crypto, which they can directly spend without manually moving funds.
2. Personalised benefits and rewards. The rewards schemes described above also of course benefit consumers, particularly when the cards are intended for use in products where consumers already have a relationship with the brand and want exclusive/early access to products or events offered by that brand. See Starbucks’ blockchain-based loyalty scheme, for example.

Consumers are not as price sensitive as merchants are when it comes to paying in crypto, as seen in the extortionate land of on-ramp providers. Merchants are securing recurring contracts and so will methodically assess competing options; consumer decisioning is far less considered. Whilst cashback and points systems have largely played out and are not meaningfully differentiating, go-to-markets can be more creative so long as the outcome is improved UX/UI and end-product engagement.

2. Building a Moat: Bundling and Optimisation

Here’s that crypto payments graph from Part 1 again:

From this you can see two important insights for crypto payments companies:

• Firstly, going after one part of the value chain — ie. just trying to be a cross-chain liquidity pool, or a stablecoin, or even an on-chain monitoring/KYC provider — is extremely difficult to scale when both margins and volume are so low
• Secondly, becoming a card issuer or other payments solution that redirects crypto capital into the customer/issuer bank (instead of the merchant/acquirer bank) simply adds more fees into the existing fiat fee structure. Binance Card, for example, handles crypto to fiat conversion and then holds the funds in their own account, thereafter interacting with the existing fiat rails

The only way to ensure a crypto payment is cheaper than a fiat one is to aggregate these offerings.

Exchanges

As seen above, a key point in the crypto chain is in the conversion to stablecoin and off-ramp providers. Rarely will one relationship with a third party be the most optimal here — the main exceptions being if the company is itself also operating the exchange in the backend (e.g. Binance Card and Binance Exchange) or if they own or have a relationship with the stablecoin issuer (e.g. Coinbase is a shareholder of Circle).

Payments start-ups cannot use volume to negotiate better rates with market makers and CEXs who can be parasitic with their terms. DeFi alternatives should therefore theoretically be preferable for pricing. And with increasing scalability solutions like Layer 2s, the marginal cost of DeFi trading in the backend will only decrease, particularly as, contrary to percentage based exchange fees on CEXs, gas fees remain constant relative to trade volume. Unfortunately, however, for the majority of assets, liquidity is too low for the kinds of volumes that payments companies need to be doing, meaning slippage is high.

That’s where aggregation solutions come in, where players can be a one-stop application for routing liquidity into different crypto primitives. Aggregators like Paraswap (WSC portfolio company), for example, split up orders into multiple exchanges to keep orders below 1% slippage.

Source: Joel John’s Newsletter, describing the difference between buying $1m in ETH in one exchange and suffering from slippage compared to splitting the order and optimising for slippage across multiple DEXs.

Given the significance of optimising for conversion routes, liquidity and pricing, aggregators are therefore also better placed to move upstream into embedded finance companies than stablecoin issuers, card issuers, or wallets.

Acquirer Banks

In the fiat world, some of the most successful companies were built on owning the acquirer bank piece of the stack, recognising that most merchants require multiple acquirers to accept each point of sale. This will often be a more efficient model than card issuer models where fees are simply added on top of the existing stack. This is because in these models, crypto funds are exchanged into fiat currencies and then deposited in an issuer bank before being sent along fiat rails into the merchant’s acquirer bank, thereby costing the usual processor, interchange, and card scheme fees on top of the crypto fee stack.

There are two types of businesses owning the acquirer bank relationship:

• Payment orchestration platforms, e.g. APEXX: route payments to the most efficient acquirer for each individual transaction based on different variables to maximise acceptance rates and minimise costs. These payment orchestrators are essentially marketplaces for acquiring banks or gateways who will then have the relationships with the acquiring banks. Ripe Money, for example, spins up new wallets to which a customer sends their crypto as ‘proof of intent’, whilst Ripe then sends fiat from one of its own bank accounts to the merchants account, keeping the crypto funds themselves.
• Payment service providers, e.g. Stripe: offer a full stack solution by becoming the payment gateway, acquirer and risk management service provider all in one, meaning merchants can operate with one payment solution rather than managing and having to integrate different solutions and multiple acquirer bank relationships. These companies eventually win out by getting their own banking licence, enabling them to operate as an acquirer bank rather than relying on banking partners to handle settlement. BoomFi (WSC portfolio company), for example, is a payments service provider handling the end-to-end conversion and settlement on behalf of its merchants.

All of this payments data is valuable in aggregation, to the point where having enough of it becomes the competitive differentiation for any business as it enables them to optimise their chosen flow of funds model. Take remittances businesses which use crypto rails in the backend to most efficiently convert — for example, 1) USD → 2) USDC → 3) Cryptocurrency → 4) Pesos. With enough data on these conversion points with exchanges, market makers/off ramp providers, and acquiring banks, they will compete by building proprietary trading algorithms to determine the optimal route from 2) → 3) → 4) in real-time. The best of these will optimise for live price movements, volume and exchange rates with different assets and exchanges to the benefit of both the end user and their own margins.

Final Thoughts

There’s currently $124bn in stablecoins sitting in people’s wallets, waiting to be spent. Cryptocurrencies will only work as well as fiat currencies if, firstly, stablecoins can earn equivalent yield, and, secondly, moving between crypto and fiat becomes price and time efficient. The ability to pay for products falls into the latter problem set. So far, these businesses are clumsily aggregating a stack of fees which are untenable for both merchants and their customers. And as we’ve seen, this can only be lowered by attracting, growing, and securing volume. As with most of B2C fintech, this is all a data game, and the winners will be those that position themselves to benefit from that; whether that be through promising merchants increased customer insights, optimising their own backend trading routes, or monetising that payments data for third parties.

Eventually, this data aggregation layer opens up entire new business models. Three such directions are:

• Selling aggregate data for insights into assets and their price movements. Target customers could include traders and hedge funds, research and analytics companies, or companies developing LLMs for trading purposes. For this to work, there needs to be an interpretive layer to on-chain data which is publicly available, or an ability to give insight to private transaction data.
• Early access to orderflow. Target customers would include exchanges and market makers who want to pay for order flow, much like the Revolut and Citadel model. For this to work, regulation needs to continue to allow payment for order flow (PFOF), which both the EU and the US’s SEC has been contemplating banning.
• Credit facilities between component parts to bridge between, for example, the redemption time from stablecoin issuers, or the request for swap and the gas-optimised time for swapping. This could be particularly interesting for payments companies who focus on optimising for gas fees by batching and timing money movements from customer wallets to aggregate deposit addresses to merchant wallets. For this to work, the delay and cost thereof needs to be considerable enough for at least one party to be willing to bear interest costs.

This remains a competitive and dynamic space in a race to solve one of the largest existing pain-points in the industry. If you’re tackling it, or want to discuss any of the above, please reach out at marthe@whitestarcapital.com.

Disclosures

White Star Capital is an investor in BoomFi, Paraswap, and Oamo. The information provided here does not constitute investment advice, financial advice, trading advice, or any other sort of advice and you should not treat any of the website’s content as such. White Star Capital does not recommend that any cryptocurrency should be bought, sold, or held by you. Do conduct your own due diligence and consult your financial advisor before making any investment decisions.