Original article by Rob Hadick, Partner at Dragonfly
Original translation: AididiaoJP, Foresight News
Stablecoins are not used to improve the existing payment network, but to completely subvert the traditional payment network. Stablecoins can enable companies to completely bypass traditional payment channels. In other words, these traditional payment channels are likely to be completely replaced one day in the future.
When the payment network is based on stablecoins, all transactions are just numerical changes in the ledger. Many emerging companies have begun to promote the reconstruction of the way funds flow.
There has been a lot of discussion lately about how stablecoins can become a platform for Banking as a Service (BaaS) networks, connecting existing payment channels, from issuing banks to merchant acceptance, and everything in between. While I agree with these views, when I think about how businesses and protocols will create and accrue value in the future under the new paradigm, viewing stablecoins as just platforms that connect to existing payment channels is actually underestimating their true potential. Stablecoin payments are an incremental improvement that represents the possibility of reimagining payment channels from the ground up.
To understand the direction of the future, we need to look back to history, because history reveals obvious evolutionary paths.
The evolution of modern payment channels
The origins of the modern payment system can be traced back to the early 1950s. Diners Club, founded by Frank McNamara, introduced the first multi-purpose debit card. This debit card introduced a closed-loop credit model, with Diners Club acting as a payment intermediary between merchants and cardholders. Prior to Diners Club, almost all payments were made directly between merchants and customers, either in cash or through proprietary bilateral credit agreements.
After the success of Diners Club, Bank of America (BofA) saw a huge opportunity to expand its credit business and reach a wider customer base, and launched the first mass-market consumer credit card. BofA mailed more than 2 million unsolicited, pre-approved credit cards to middle-class consumers, which could be used at more than 20,000 merchants in California. Due to regulatory restrictions at the time, BofA began to license its technology to other banks in the United States and even expanded to international markets, thus emerging as the first credit card payment network. However, it was accompanied by huge operational challenges and triggered serious credit risks, with delinquency rates soaring to more than 20%. At the same time, accompanied by rampant fraud, the entire project nearly collapsed.
People began to realize that the challenges and chaos in the banking network could only be solved by forming a true cooperative organization that would set the rules and provide the infrastructure to manage the system. Members of the organization could compete on product pricing, but needed to follow a unified standard. This organization later became Visa as we know it today. And another organization founded by the Bank of California to compete with Bank of America later became Mastercard. This was the birth of our modern global payment model and has become the dominant structure in the global payment industry.
From the 1960s to the early 2000s, almost all innovation in the payments space revolved around enhancing, supplementing, and digitizing current global payment models. After the Internet boom in the 1990s, much of the innovation shifted to software development.
E-commerce was born in the early 1990s, with the purchase of Stings CD on NetMarket being the first online payment. PizzaNet later became the first national retailer to accept online payments. Amazon, eBay, Rakuten, Alibaba and other well-known e-commerce companies were established in the following years. The prosperity of e-commerce companies gave rise to many early independent payment gateway and processor companies. The most famous are Confinity and X.com, which were established in late 1998 and early 1999 respectively, and merged to become todays PayPal.
Digital payments have spawned many household names with market capitalizations of hundreds of billions of dollars. These companies connect offline merchants and online retail, including payment service providers (PSPs) and payment aggregators (PayFacs), such as Stripe, Adyen, Checkout.com, Square, etc. They solve merchant-side problems by bundling gateways, processing, reconciliation, fraud compliance tools, merchant accounts, and other value-added software and services. But they obviously have not made disruptive changes to the payment network of traditional finance.
While there are some startups focused on disrupting traditional bank payment networks and card issuance infrastructure, well-known companies such as Marqeta, Galileo, Lithic and Synapse are mainly focused on disrupting existing payment networks by introducing new companies into existing bank networks and infrastructure. However, many companies have found that simply adding a software layer on top of the existing infrastructure does not achieve real explosive growth.
Some companies are well aware of the limitations of traditional payment methods and foresee that they can build payment solutions that are completely independent of traditional banking infrastructure through Internet-based native currencies. The most famous of these is PayPal. In the early 21st century, many startups focused on the research and development of digital wallets, peer-to-peer transactions, and alternative payment networks. These companies completely bypass banks and card issuing alliances, allowing end customers to have a certain degree of monetary autonomy. These companies include PayPal, Alipay, M-Pesa, Venmo, Wise, Airwallex, Affirm, and Klarna.
They initially focused on providing better user experience, product portfolios, and cheaper transactions for groups neglected by traditional finance, but gradually began to seize more and more market share. Traditional financial payment companies felt the threat of these alternative payment methods (APMs), and then Visa and Mastercard launched Visa Direct and Mastercard Send, respectively, also focusing on providing real-time payment services for peer-to-peer transactions. Although these models have been significantly improved, they are still plagued by the limitations of existing infrastructure. These companies still need to pre-deposit funds or bear foreign exchange/credit risks, and need to hedge their own capital pools against each other, without being able to achieve instant and transparent settlement.
In essence, the evolution path of modern payment is: closed loop + trusted intermediary → open loop + trusted intermediary → open loop + partial personal autonomy. However, opacity and complexity still dominate, resulting in a worse user experience and rent extraction in every link of the entire network.
The Evolution of Merchant Payments
Enterprises can bypass some or all of the technical infrastructure of traditional payment networks through stablecoins. The following figure is a simplified merchant payment diagram:
And the responsibilities of each part of the stablecoin payment network:
Currently, Stripe can handle a large part of the work on the merchant side, including providing merchant accounts and various software for operating businesses and accepting payments. However, they have not formed their own card issuing organization or issued payment cards.
Now imagine a world where Stripe becomes the central bank, issues its own stablecoin, backed by approved collateral under the GENIUS Act. Stablecoins can be atomically settled between consumer and merchant accounts on a transparent open-source ledger (blockchain). Instead of having a card bank and an acquiring bank, Stripe (or any other issuer) only needs one (or a few) banks to hold collateral for its issued stablecoins. They transact directly on the blockchain through wallets, or by making mint/redemption requests to Stripe (the issuer/central bank), which are then settled on the blockchain. Clearing and settlement of funds is done through a series of smart contracts that can handle chargebacks and disputes (see Circle’s chargeback protocol). Similarly, payment routing and even conversions to other currencies/products can be done programmatically. With stablecoins and blockchain technology, it becomes easier to standardize data delivery from banks to gateways, processors, and networks. Fees and bookkeeping become simpler with transparency of data and fewer stakeholders.
In such a world, Stripe seems to have almost completely replaced the current payment model - owning the entire infrastructure, providing accounts, card issuance, credit, payment services and networks, all built on better technology, thus reducing the middlemen and giving wallet holders almost complete control over the flow of funds.
Simon Taylor: “If you use stablecoins as the basis, all transactions are just digital changes on the ledger. Merchants, gateways, PSPs and banks previously needed to reconcile different ledger entries. With stablecoins, anyone who uses stablecoins to operate is also a gateway, PSP and acquiring bank, and all transactions are just digital changes on the ledger.”
This sounds like science fiction. Are there many issues related to fraud, compliance, availability of stablecoins, liquidity/cost, etc.? Will there be incremental steps between today and this potential future? Technologies like real-time payments (RTPs) also have flaws, and programmability and interoperability for cross-border remittances are issues that RTPs cannot solve.
Regardless, the future is coming, and some companies are preparing for it. Top issuers such as Circle, Paxos, and withausd are expanding their products, and payment-focused blockchains Codex, Sphere, and PlasmaFDN are also moving closer to end consumers and businesses. The payment network of the future will significantly reduce the number of intermediaries, increase autonomy, improve transparency, enhance interoperability, and bring more value to customers.
Cross-border payments
B2B cross-border payments are one of the areas where stablecoin applications are currently growing significantly.
Matt Brown wrote an article last year about cross-border payments, from which we can see:
In many cases, there are multiple banks in the middle of a cross-border transaction, and they all use SWIFT to transmit information. There is nothing wrong with SWIFT itself, but the communication between banks creates additional time costs, and usually involves other clearing counterparties. In fact, the clearing process usually takes 7-14 days to complete, which undoubtedly brings huge risks and costs, and the process is extremely opaque. For example, it is not uncommon for JPMorgan Chase to lose millions of dollars for a long time when transferring funds from its US parent company to foreign subsidiaries. In addition, there is foreign exchange risk between multiple counterparties, which increases the average transaction cost by 6.6%. In addition, when a companys funds flow across borders, it is almost impossible to earn interest.
It’s no surprise then that Stripe recently announced the launch of stablecoin-based financial accounts. This enables businesses to access a USD financial account backed by stablecoins, mint/redeem stablecoins directly through Bridge, and transfer funds to other wallet addresses through the Stripe dashboard. Use the Bridge API for fiat on/off, issue payment cards backed by stablecoin balances (depending on region, currently using Lead Bank), exchange to other currencies, and ultimately directly exchange to interest-bearing products for fund management. While many functions currently still rely on legacy systems as a temporary solution, the sending, receiving, issuance, and exchange of stablecoins and tokenized assets do not rely on legacy systems. The solution for fiat on/off is similar to the current state of alternative payment methods (APMs), where companies like Wise and Airwallex have essentially created their own network of banks that can park funds in different countries and net them out at the end of the day. Jack Zhang, co-founder of Airwallex, correctly pointed this out last week, but he failed to consider how the world would change if fiat on/off was no longer needed.
If you simply buy tokenized assets with stablecoins without exchanging them for fiat, you essentially bypass the traditional correspondent banking model entirely. This will greatly reduce users’ reliance on third parties to actually hold and send assets, allowing customers to capture more value and reducing payment costs for everyone. Startups such as Squads protocol, Rain cards, and Stablesea are all working on making it possible to buy and sell tokenized assets directly with stablecoins, and all companies operating in this space will eventually expand to the entire network.
But if you want to convert your stablecoins to fiat, Conduit Pay can work directly with the largest FX banks in the local market to enable seamless, cheap, and almost instant on-chain cross-border transactions. Wallets become accounts, tokenized assets become products, and blockchains become networks, which significantly improves the user experience and can be even cheaper if fiat deposits and withdrawals are not required. All of this can be achieved with better technology and can provide simpler reconciliation, more autonomy, greater transparency, faster speeds, stronger interoperability, and even lower costs.
So what does all this mean?
This means that a world of payments natively based on stablecoins (digital changes on the ledger) that exists on the chain is coming. It will not only connect the current payment model, but will gradually replace it. This is why we will see the first trillion-dollar fintech company based on stablecoins is about to be born.
I know this post will invite many legitimate criticisms that I have not considered certain issues. But please understand that I and many entrepreneurs working in this space are aware of these issues and are working to address them. Innovation being what it is, incremental building on top of old systems will never truly lead to entirely new systems because vested interests will always prevent that from happening.
Closed loop + trusted intermediary → open loop + trusted intermediary → open loop + partial personal autonomy → a truly open digital native system where everyone can compete across the entire payment network and customers exercise autonomy through an open network.
The opinions expressed in this article are the author’s own and not necessarily those of Dragonfly or its affiliates. Dragonfly may have invested in some of the protocols or cryptocurrencies mentioned in this article.
