Qiming Venture Partners Larry Liu's In-Depth Analysis of Cryptocurrency Payments (Part 2): Potential and Current Status

Original link: 《The Last Big Thing - Crypto Payment Part2》

Original author: Larry Liu, Qiming Venture Partners

Translation by: Scof, ChainCatcher

Edited by: flowie, ChainCatcher

Editor's note: Crypto payments are one of the hottest sectors recently. In addition to Stripe's $1 billion acquisition of the stablecoin payment startup Bridge, creating the largest acquisition in crypto history, many mainstream financial institutions have begun to accelerate their layout in crypto payments:

• PayPal completed its first commercial payment using the stablecoin PYUSD.
• Visa launched the tokenized asset platform VTAP to help banks issue fiat-backed tokens.
• BlackRock partnered with Ethena to launch a new stablecoin supported by BlackRock BUIDL.
• Coinbase and A16Z jointly invested in the AI crypto payment company Skyfire.
• ……

Crypto payments are also experiencing a financing boom. As seen in the crypto payment financing statistics article released by ChainCatcher in September, crypto payment financing has recently gathered giants from various fields such as payments, stablecoins, and traditional finance. Visa, Tether, Circle, JPMorgan Chase, and Standard Chartered are all rushing to enter the market, while top-tier capital such as Sequoia Capital, Temasek, and A16Z are also placing their bets.

Recently, well-known investment fund Qiming Venture Partners investor Larry Liu published a ten-thousand-word series article 《The Last Big Thing - Crypto Payment》, systematically discussing the future of crypto payments from the perspectives of payment historical changes, the current state and trends of crypto payments. ChainCatcher has compiled this.

The first article in this series explores the panorama of traditional payment systems from the origins of credit card payments to modern digital transformation.

This article is the second part, discussing the unique advantages of blockchain technology in payments and assessing the current state of crypto payments. The final part will analyze emerging trends and revolutionary possibilities.

3. Entering Crypto Payments

3.1 Advantages and Reasons

So, what are the benefits of cryptocurrencies and blockchain?

3.1.1 Democratized Access

① Public blockchains democratize access to digital assets and ownership through their permissionless and decentralized networks. Node operators can benefit from diverse revenue streams, enabling them to serve a wide audience that traditional banks and payment systems cannot reach.

Traditional digital payment systems have reduced the marginal cost of serving additional customers to nearly zero. In contrast, public blockchains often incur additional overhead due to communication costs and redundant work among multiple nodes. However, node operators largely rely on token issuance and other diverse revenue sources, rather than just transaction fees.

Taking Ethereum node revenue as an example:

Current situation:

• Consensus layer rewards
• Token issuance - 82.5%
• Execution layer rewards:
• Priority Gas fees (processing fees) - 11.7%
• Baseline MEV (Miner Extractable Value) - 5.9%

Breakdown of Ethereum node revenue. Source: Rated Network

In the past 30 days, token issuance accounted for 82.5% of node revenue, while priority Gas fees (similar to payment processing fees in traditional systems) accounted for only 11.7%. Although the annualized return rate of 3.42% seems moderate, it is denominated in ETH and carries relatively low risk. The scale of funds involved is substantial, with approximately 33 million ETH staked, totaling over $100 billion—about 3.7‰ of the U.S. GDP in 2023, or equivalent to the total amount of U.S. national debt—all of which is denominated in ETH, with annual returns exceeding 3%. Looking ahead, revenue sources are expected to further diversify, with non-issuance rewards accounting for a larger share.

These rich revenue sources and high-value transactions make operating nodes a profitable business, especially when specialized. While some argue that L2 may not benefit from Proof of Stake (PoS) staking, launching their own tokens, internalizing Gas fees, and potentially earning MEV revenue can easily offset these disadvantages.

We further delve into the concentration of revenue at the transaction level. Data shows that the top four transaction types contribute over 60% of total MEV, while they occupy only about 22% of block space (measured by Gas fees). These transaction types—Telegram bot flows, sandwich MEV, bot swap flows, and non-atomic arbitrage MEV (essentially arbitrage between centralized and decentralized exchanges)—are primarily transaction-related rather than transfer or other activities. These complex transaction operations provide significant economic returns to node operators who maintain and secure the network infrastructure. Combined with the composability of technology, this creates a decentralized network that serves a broader audience.

Order flow analysis. Source: "Who Wins Ethereum Block Building Auctions and Why?" by Burak Öz, Danning Sui, Thomas Thiery, Florian Matthes

3.1.2 Neutral and Transparent Environment

② Public blockchains excel at eliminating trust assumptions and the friction of cross-party collaboration that comes with them. Essentially, they provide a neutral and transparent environment secured by trustless data processing and computation.

If you have a deposit account in the U.S. and want to send money to your family in Southeast Asia through a bank, you have several options, but none are ideal.

Traditional bank transfers typically take 3-5 days and incur fees ranging from 1-5%. Remittance service providers can help you complete transfers faster, usually within minutes or hours, but at a higher cost, typically between 5-10%. Even most online services, while more convenient, usually only complete transfers within 1-2 days, with fees between 0.5-2%. Additionally, currency conversion may add another 0.5-5% in fees, depending on the provider and many other factors.

The main reason for these lengthy and costly processes is that different banks and countries maintain independent "ledgers." Each bank maintains its own accounting system, and even global banks typically keep separate ledgers for different regions or countries.

Currently, SWIFT is the primary messaging network used by banks to route global remittances. When you initiate a transfer, your bank deducts funds from your account and sends a message to the receiving bank via SWIFT. The receiving bank then processes that information and credits the funds. If the two banks do not have a direct relationship, they must rely on one or more intermediary banks to route the information and funds.

These intermediary banks may be located in different time zones, have varying levels of digitization, and follow their own processes and policies. Some banks prefer to batch process international transfers rather than handle them in real-time. All these factors lead to significant delays and high costs.

Similar situations occur daily across almost all industries. Whether individuals, companies, organizations, regions, or entire countries, parties act in their own interests—cooperating when advantageous but also competing with each other. Economic theory often suggests that such situations can promote optimal efficiency and maintain societal vitality. However, this undoubtedly brings countless prisoner dilemmas, tragedy of the commons, and walled gardens. This introduces significant friction in cross-interest collaboration, often making such interactions complex, expensive, and in some cases, untenable.

Blockchain offers a transformative approach. It treats all participants equally and ensures that every node maintains an identical ledger, known as the authoritative chain. Through strict consensus mechanisms and cryptographically protected account systems, blockchain ensures that all applications and accounts operate strictly according to open-source code rules. This framework allows users to manage the same account from any location and transfer funds to anyone anywhere in seconds.

A "on-chain" bank can communicate directly with other banks because they all operate on the same public ledger. This ledger is not only universally accessible, but any participant can verify it, eliminating the need for trust and reducing wait times. With blockchain, a farmer in rural China can conduct secure, trustless transactions with a financial service provider in a skyscraper on Wall Street. This is the power of blockchain: removing barriers, enhancing transparency, and democratizing access to finance and other services globally.

3.2 Current Status Check

Despite its immense potential, crypto payments are still in their early stages of development and face significant challenges. These challenges include the rigidity of existing widely adopted payment systems, resistance from established user habits, and the entrenched interests of financial giants. While Satoshi envisioned Bitcoin as widely used digital cash, most goods and services in our daily lives are still priced in fiat currency, so the focus here is primarily on stablecoin payments.

3.2.1 Just Adding Extra Steps to Traditional Payment Methods

Ironically, many current crypto payment solutions add extra steps to traditional payment methods. Take crypto debit cards as an example, which are the most common products in this field.

Current "crypto payment" typical workflow.

While it is often believed that crypto payments may first gain adoption in underdeveloped areas lacking traditional banks and cards, I think it is more practical and symbolic to start with cards at this stage of the industry. The key strategy here is to leverage the existing Visa and MasterCard networks, which cover over 150 million merchants in more than 200 countries and regions. Without taking this approach, we would have to persuade merchants one by one to adopt new payment methods or convince existing payment platforms to integrate with crypto systems—both of which seem unrealistic at this stage.

Typically, the first to enter this field are issuing banks or downstream entities that collaborate with issuing banks to leverage their issuance capabilities. When issuing banks promote the ability to use their cards for crypto payments, it usually involves converting cryptocurrencies into fiat currency beforehand. This is often done through an OTC provider or managed by the issuing bank on behalf of the user. Once this process is completed, you can use the card for payments, but in reality, transactions are conducted in fiat currency, with little relation to cryptocurrencies.

In this case, the credit card is backed by sufficient assets, referred to as "secured credit cards." This blurs the line between credit cards and debit cards, making the distinction between the two almost negligible. While credit cards, debit cards, prepaid cards, and other payment forms differ in terms of spending limits, usage scenarios, and fee structures—differences that may vary by country and region—the focus here is primarily on typical card payments without discussing the specific nuances between the various types.

This approach somewhat caters to native crypto users, especially those who have allocated significant assets in cryptocurrencies but still need to use fiat for daily expenses. However, this method is not ideal and has several significant drawbacks:

1. Custodial and Centralization Risks: During the period of funding the card and making payments, users' assets are effectively in custody, either with the issuer or with a specialized custodian. This introduces potential centralization risks and complicates account management. Users must actively manage their fiat account balances and face the risk of issues arising with custodians. Additionally, this also brings opportunity costs, as users miss out on potential gains that could be earned through staking or other decentralized finance protocols. Although some issuers are beginning to offer yields to users, this often involves lending funds to asset managers, thereby introducing additional risks and costs.
2. Increased Complexity and Costs: Contrary to the intention of simplifying transactions and reducing intermediaries, this method actually adds more steps and intermediaries to the payment process. Currently, service providers typically charge a fee of 1%-3% just for reloading the card, which is directly borne by the cardholder.

3.2.2 Factors Preventing Non-Custodial Payments

Given these issues, the question arises: why can't users sign payment transactions in real-time? Why must they be converted to fiat beforehand?

Providers:

1. Latency: When using traditional payment channels, card issuers need to confirm payments within about 5 seconds to ensure a smooth user experience and reduce potential security risks. However, on L1s like Ethereum, this time window is often insufficient to package transactions, let alone achieve final confirmation.
2. Double Spending: While real-time authorization on L2 or high-performance L1s is technically feasible, there are still some risks. For example, transactions may be reverted due to chain reorganization or network failures. Transactions pre-confirmed by rollup sequencers may be inadvertently or intentionally ignored. Additionally, sophisticated attackers may cover their original transactions by paying higher Gas fees, allowing them to transfer assets to another address before the original transaction is finally confirmed.

Overall, the biggest risk faced by payment providers or card issuers in non-custodial payment systems is the failure to receive tokens as expected, in which case the provider would need to compensate for the loss with their own funds.

Attackers causing distress to service providers through double spending

Users:

1. Gas Fees: One of the significant challenges users face in crypto payment systems is Gas fees. On L1s, Gas fees can be prohibitively high, and even on L2s or cheaper L1s, Gas fees may still be unacceptable for high-frequency, low-value transactions (such as daily payments).
2. Signing and Management: So far, card swiping does not support signing crypto transactions. Instead, users must manually sign each transaction using a mobile phone or hardware wallet, which is not ideal. Furthermore, the process of signing and managing keys on mobile devices is neither smooth nor secure. Corporate clients also typically expect more granular access control.

Is it possible to provide solutions to address all these issues? With the introduction of several new primitives, the answer is affirmative.

The final article in this series will explore emerging trends that may overcome these challenges and fundamentally change the landscape of crypto payments.