Payments, especially those across borders, are often touted as a key use case and value proposition for the blockchain industry. Unfortunately, a look at both the technology, competition, and regulatory environment doesn’t really support that idea. And the launch of FedNow by the Federal Reserve in late-July is a good occasion to take a look at why, for most people and companies, the value proposition of using crypto or blockchains for basic payment services isn’t very appealing.
Paul Brody is Global Blockchain Leader for EY (Ernst & Young). Under his leadership, EY is established a global presence in the blockchain space with a particular focus on public blockchains, assurance, and business application development in the Ethereum ecosystem.
Blockchains and crypto ecosystems have compelling advantages in other areas, but fiat payments aren’t one of them. First and foremost, simple, high-volume payments are cheaper and faster to execute in centralized systems. Blockchains have complex consensus mechanisms and many nodes in which ledger data is distributed. This means that while centralized payments flow quickly through a single infrastructure, blockchain payments get copied to thousands of nodes and are subject to varying degrees of speed and cost based on network congestion.
Transaction fees for FedNow are expected to be in the range of $0.05 each or less. Automated Clearing House (ACH), the most common inter-bank payment method in the U.S., presently costs between $0.25 and up depending on the provider. Bitcoin fees average around $1, though they can vary a lot, and transaction fees on Ethereum are similarly high and variable. Both Bitcoin and Ethereum have accelerator networks that can bring costs back down towards $0.04, though these are not yet widely available and we don’t have experience with large volumes to know if they will stay that low.
The second big obstacle to widespread adoption of blockchain payments is path dependency. We already have widely deployed simple payment systems linked to debit cards and bank accounts. It’s rare for new technologies to come in and wipe out older infrastructure unless it has a compelling advantage and, in most cases, blockchain payments are at best price competitive, but without many advanced features that retailers and others depend upon for handing things like chargebacks, refunds and loyalty points.
One area that is often cited by blockchain and crypto boosters as particularly promising is cross-border remittances. In these cases, fees in the traditional banking and payment systems are quite high and many people are simply not served by that system because they don’t have bank accounts. Unfortunately, the root cause of high fees and lack of services isn’t a technological one that can be fixed with blockchains. The real obstacles that add cost are often regulatory, infrastructure or a lack of competition.
The regulatory problem is mainly that in some countries, the law does not permit banks to open accounts for people with limited or no personal identity documentation or whose documentation would show them to be working or living in that country illegally. Where those obstacles have been eased or governments have made it a priority to bank the unbanked, banks have been quick to serve these groups. Brazil, India, Kenya and Tanzania are all shining examples of how quickly banks and financial services entities can charge into a market when the regulatory and identity obstacles are eased. All these countries have thriving markets for low-income users that have “banked” millions of in recent years.
The second big cost driver for cross-border payments is a combination of infrastructure and regulation. By infrastructure here, I don’t mean computing infrastructure, I mean the physical variety: supply chains for moving money and disbursing it. Sending cash from one person to another requires physical infrastructure to receive and disburse cash. Western Union is reported to have over 500,000 access points worldwide and their competitor, MoneyGram, claims as many as 300,000. Physical retail costs more to maintain purely online systems and also acts as a huge competitive differentiator. Incumbents have been building their retail networks for literally decades. Western Union has been in the money transfer business since 1871.
It’s instructive to compare online to online payments with cash-to-cash payments at companies that offer cross-border remittances. I did a quick survey looking at two providers and two currencies and fees ranged from 1-2% for entirely digital payments to 5% or more for a transfer of $250 in physical cash from and to a retail location.
Where it makes sense
While I think the odds of blockchain payments replacing credit cards or debit cards are low, there are two cases where I think blockchains have exceptional value. And I think it is in those areas where blockchains have immense value to create in the payment space.
The first is in everything that isn’t traditional fiat money. The banking system is an amazing set of infrastructure that does an astonishingly good job of moving lots of money reliably and at low cost. And none of it works for anything other than money. The genius of tokenization is that you can apply the discipline that banks bring for money (the prevention of double spend) to anything of value.
The second compelling value proposition is that you can make payments in the exact same ecosystem in which you take delivery of the item you are buying. Every transaction involves the exchange of money for stuff. In the real world, the money and the stuff reside in completely different systems. The can of soda you buy in a convenience store is tracked in a different inventory system and your payment comes through the banking system. The real cost of this transaction isn’t the payment, it’s the reconciliation across all the different systems.
Instead of chasing a deeply entrenched incumbent payment system, blockchain and crypto businesses should be going after the opportunities where they offer compelling advantages for consumers and businesses. The flexibility and programmability of the blockchain ecosystem is costly but offers compelling advantages the moment you add any kind of complexity to a transaction from simple reconciliation all the way up to complex business logic.