Galaxy Digital: What are the emerging trends in the cryptocurrency payment sector?

Original Title: 《 The Future of Payments 》

Author: Mike Giampapa, General Partner at Galaxy Ventures

Compiled by: Luffy, Foresight News

Payments were a key use case emphasized in the Bitcoin white paper of 2008. Over the past few years, blockchain-based payments have become increasingly viable and popular compared to traditional payment methods. Billions of dollars have been invested over the past decade to develop the underlying blockchain infrastructure, and now we have systems capable of enabling "scaled payments."

The cost and performance curve of blockchain aligns with "Moore's Law," and the cost of storing data on the blockchain has decreased by several orders of magnitude in recent years. After the Ethereum Dencun upgrade (EIP-4844), the average cost per transaction on Layer 2 networks like Arbitrum and Optimism has dropped to $0.01, while the transaction costs on alternative Layer 1s are also nearing a few cents.

In addition to better performance and cost-effective infrastructure, the rise of stablecoins has been explosive and persistent, clearly indicating a long-term trend in the turbulent cryptocurrency industry. Visa recently launched a public stablecoin dashboard (Visa Onchain Analytics), giving us a glimpse into this growth trend and demonstrating how stablecoins and the underlying blockchain infrastructure can facilitate global payments, with the total stablecoin transaction volume in the market increasing approximately 3.5 times year-over-year. When focusing the analysis on transaction volumes seemingly initiated directly by consumers and businesses (excluding automated transactions or smart contract operations), Visa estimates that the stablecoin transaction volume over the past 30 days was approximately $265 billion (annualized transaction volume of about $3.2 trillion), roughly double PayPal's payment volume in 2023, and approximately equivalent to the GDP of India or the UK.

Source: Visa Onchain Analytics

We have spent considerable time delving into the fundamental drivers of this growth and firmly believe that blockchain has tremendous potential to become the mainstream payment method of the future.

Background of the Payment Industry

To grasp the fundamental drivers of growth in the cryptocurrency payment market, we must first understand some historical context. The payment infrastructure used internationally today (e.g., ACH, SWIFT) was established over 50 years ago in the 1970s. The ability to remit money globally was a groundbreaking achievement and a milestone in finance.

However, the global payment infrastructure is now essentially outdated and fragmented. It is an expensive and inefficient system that operates within limited banking hours and relies on numerous intermediaries. A significant issue with the current payment infrastructure is the lack of global standards. This fragmentation hinders seamless international transactions and complicates the establishment of consistent protocols.

The emergence of real-time settlement systems has been a significant advancement in recent years. The success of international real-time payment solutions, such as India's UPI and Brazil's PIX, has been well-documented. In the U.S., government and consortium-led efforts have introduced real-time settlement systems like Same Day ACH, the Clearing House's RTP, and the Federal Reserve's FedNow. The adoption of these new payment methods has been stifled, with divisions among competing interests presenting significant challenges.

Fintech companies have attempted to improve user experiences on top of this traditional infrastructure. Companies like Wise, Nium, and Thunes enable customers to pool liquidity from global accounts, allowing users to feel that transactions are completed instantly. However, they have not broken through the limitations of the underlying payment channels and are not capital-efficient solutions.

Complexity of Today's Payments

Given the fragmentation of the existing financial system, payment transactions have become increasingly complex. This situation can best be illustrated by the structure of cross-border payment transactions, which contain many pain points:

Source: Galaxy

• Multiple intermediaries: Cross-border payments often involve multiple intermediaries, such as local banks and correspondent banks, clearinghouses, forex brokers, and payment networks. Each intermediary adds complexity to the transaction process, leading to delays and increased costs.

• Lack of standardization: The absence of standardized processes leads to inefficiencies. Different countries and financial institutions may have varying regulatory requirements, payment systems, and information transmission standards, making it challenging to streamline payment processes.

• Manual processing: Traditional systems lack automation, real-time processing capabilities, and interoperability with other systems, resulting in delays and manual intervention.

• Lack of transparency: The opacity of cross-border payment processes can lead to inefficiencies. Limited visibility into transaction status, processing times, and associated fees can make it difficult for businesses to track and reconcile payments, resulting in delays and management overhead.

• High costs: Cross-border payments often incur high transaction fees, exchange rate markups, and intermediary fees.

Cross-border payments can typically take up to 5 business days to settle, with an average cost of 6.25%. Despite these challenges, the market size for B2B cross-border payments remains enormous and continues to grow. FXC Intelligence estimates that the total market size for B2B cross-border payments in 2023 is $39 trillion, expected to grow by 43% to $53 trillion by 2030.

Clearly, real-time settlement is urgent, but a unified global payment standard has yet to emerge. Fortunately, there is a solution available to everyone that can transfer value instantly and cheaply around the world—blockchain.

Source: Galaxy (All third-party company product and service names in this presentation are for identification purposes only)

Adoption of Crypto Payments

Stablecoin payments provide an ideal solution to the current challenges in areas like cross-border payments, and stablecoins are experiencing long-term growth globally. As of May 2024, the total supply of stablecoins is approximately $161 billion. USDT and USDC rank third and sixth, respectively, in cryptocurrency market capitalization. Although their combined market cap accounts for only about 6% of the cryptocurrency market, their on-chain transaction value represents about 60% of the entire crypto market.

Looking back at our cross-border payment example, the streamlined flow of funds provided by blockchain offers an elegant solution to the current complexity dilemma:

Source: Galaxy

• Near-instant settlement: Compared to most traditional financial payment methods that take days to settle, blockchain can settle transactions globally in near real-time.

• Lower costs: By eliminating various intermediaries and technical infrastructure, crypto payment costs are lower compared to existing products.

• Greater visibility: Blockchain provides a higher level of visibility in tracking the flow of funds and alleviating management costs associated with reconciliation.

• Global standards: Blockchain offers a "highway" that anyone connected to the internet can easily access.

Stablecoins can significantly simplify payment processes and reduce the number of intermediaries. Compared to traditional payment methods, the flow of funds can be visible in real-time, with faster settlement times and lower costs.

Overview of the Crypto Payment Stack

When we examine the crypto payment market, we find that the stack primarily consists of four layers:

Source: Galaxy (All third-party company product and service names in this presentation are for identification purposes only)

Settlement Layer

The underlying blockchain infrastructure for settling transactions. Layer 1 blockchains like Bitcoin, Ethereum, and Solana, as well as general Layer 2 solutions like Optimism and Arbitrum, are selling block space to the market. They compete on multiple fronts, including speed, cost, scalability, and security. We expect that over time, payment use cases will become significant consumers of block space.

Asset Issuers

Asset issuers are entities responsible for creating, maintaining, and redeeming stablecoins, which are crypto assets designed to maintain a stable value relative to a pegged asset or a basket of assets (most typically the U.S. dollar). Stablecoin issuers typically adopt a bank-like balance sheet-driven business model, absorbing customer deposits and investing them in higher-yielding assets like U.S. Treasuries, then issuing stablecoins as liabilities, profiting from the spread or net interest margin.

On/Off Ramps

On/off ramp providers play a critical role in enhancing the availability and adoption of stablecoins as a primary mechanism for financial transactions. Fundamentally, they serve as the technical layer that connects stablecoins on the blockchain with fiat currencies and bank accounts. Their business models are often traffic-driven, earning small commissions from the volume of dollars flowing through their platforms.

Interfaces / Applications

Front-end applications are ultimately the customer-facing software in the crypto payment stack, providing user interfaces for crypto payments and leveraging other parts of the stack to facilitate such transactions. Their business models vary, but they often consist of a combination of platform fees and traffic-driven fees generated from front-end transaction volumes.

Emerging Trends in the Crypto Payment Space

In the intersection of cryptocurrency and payments, there are many trends that excite us:

Cross-Border Payments as the First Battlefield

As mentioned, cross-border transactions are often the most complex, least efficient, and most expensive due to the numerous intermediaries profiting along the way. Therefore, we see the highest acceptance of blockchain-based alternative payment solutions in the market. Providers supporting B2B payments (paying suppliers and employees, corporate finance management, etc.) and remittance use cases are being highlighted in the market.

We believe that cross-border payments are akin to logistics, where the "last mile" (the entry and exit points between fiat and cryptocurrency) is particularly challenging to navigate. This is precisely where companies like Layer2 Financial provide real value, as they take on the integration burden with various backend cryptocurrency and fiat currency partners (blockchains, custodians, exchanges/liquidity providers, banks, traditional payment channels, etc.) and offer customers a seamless and compliant experience. Layer2 also helps facilitate high-speed/low-cost routes for transactions and can complete the entire lifecycle of cross-border payments using cryptocurrency in as little as 90 minutes, which is 1-2 orders of magnitude faster than existing solutions.

Given the cost and efficiency improvements, we see adoption of this technology across all regions and end customers (both crypto-native businesses and traditional enterprises). The demand is particularly high in regions where fiat currencies are less stable and the use of the dollar is inconvenient. For these reasons, Africa and Latin America have been hotbeds of entrepreneurial activity. For example, Mural has achieved significant success in helping customers facilitate payments between suppliers and developer contractors in the U.S. and Latin America.

Early Stages of Supporting Payment-Level Infrastructure

Most market infrastructure surrounding the crypto ecosystem (e.g., custodial platforms, key management systems, liquidity venues) has primarily been built for retail trading. Over the years, this ecosystem has matured to include more enterprise/institutional-grade software and services, but overall, this infrastructure has not been built to support the real-time nature and scale of payments.

We see opportunities for new entrants and existing providers to launch/expand their products to capture this emerging use case. For example, new custodial/key management systems like Turnkey have improved transaction signing efficiency by about two orders of magnitude, reducing signing latency for millions of wallets to 50-100 milliseconds. They also enable companies to design policies around asset operations to enhance automation and process scalability.

Liquidity partners are also realigning their products to provide more frequent (ideally real-time) settlement capabilities for on/off ramp providers. More automation is being fully realized, which will provide a better experience for end users.

On-Chain Yield Will Change the Game

Issuing digital fiat currency on the blockchain is the first instance of the tokenization trend. As mentioned, we see significant growth in stablecoin adoption, but holders of these assets cannot earn yield on their holdings (relative to 4-5% on U.S. Treasuries).

Currently, Tether/USDT and Circle/USDC dominate the stablecoin market, accounting for over 90% of the approximately $160 billion stablecoin market. Recently, we have seen a series of new entrants offering on-chain yield in various forms. Stablecoin issuers like Agora, Mountain, and Midas are providing yield-bearing assets pegged to the dollar, offering returns or rewards to holders. We have also seen companies like BlackRock, Franklin Templeton, Hashnote, and Superstate launch a range of tokenized U.S. Treasury products to provide on-chain yield. Finally, we see creative tokenization structures like Ethena offering a synthetic asset pegged to the dollar that uses ETH-based transactions to provide on-chain yield.

We expect these new assets to be a significant catalyst for the expansion of on-chain finance. A yield asset market is emerging, and we see a future where users can leverage specific tools based on use cases, risk/return preferences, and their regions. This could have transformative effects on global financial services.

Early Signs of Stablecoin Usability

While stablecoins have a clear product-market fit across various use cases, the daily lives of non-crypto natives typically occur in the fiat currency world. For example, businesses may be eager to leverage stablecoins and blockchain for cross-border payments, but most companies today prefer to hold and accept fiat currency.

One barrier is the ability of businesses to accept stablecoin payments. Stripe recently announced support for its merchant clients to accept stablecoins, marking a significant shift in the status quo. This can provide consumers with more payment options and make it easier for businesses to accept, hold, and trade digital assets.

Another barrier is the ability to use stablecoins. Visa has expanded its stablecoin settlement capabilities to support tighter interoperability between blockchain and the Visa network. For example, we see organic demand for stablecoin-supported card products that allow cardholders to use their stablecoins anywhere Visa cards are accepted.

As stablecoins become more widely accepted and used in traditional payment methods, we increasingly anticipate that these digital assets will become ubiquitous alongside non-digital assets.

Conclusion

Blockchain-based payments are one of the most significant and exciting trends we see at the intersection of cryptocurrency and financial services. We believe that blockchain will be used to settle an increasing number of financial transactions, and payments will become a key use case and major consumer of block space in the future.