Stablecoins rebuild the payment system: Traditional finance models face fundamental changes.

Author: Rob Hadick, Partner at Dragonfly

Compiled by: AididiaoJP, Foresight News

Original Title: The traditional payment model is on the verge of collapse, and a trillion-dollar stablecoin financial company is about to be born?

Stablecoins are not meant to improve the existing payment networks, but rather to completely disrupt traditional payment networks. Stablecoins enable businesses 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 payment networks are based on stablecoins, all transactions are merely changes in the numbers on the ledger. Many emerging companies are already beginning to promote a reconstruction of the way funds flow.

Recently, many people have been discussing how stablecoins can become a banking-as-a-service (BaaS) network platform, connecting existing payment channels from issuing banks to merchant acceptance, and everything in between. While I agree with these viewpoints, when I think about how enterprises and protocols can create and accumulate value in the future under a new paradigm, viewing stablecoins merely as a platform to connect existing payment channels actually underestimates their true potential. Stablecoin payments represent a gradual improvement and signify the possibility of reimagining payment channels from the ground up.

To understand the direction of the future, we need to review history, as history reveals the obvious path of evolution.

The Evolution of Modern Payment Channels

The origins of modern payment systems can be traced back to the early 1950s. Diners Club, founded by Frank McNamara, launched the first multipurpose charge card. This charge card introduced a closed-loop credit model, making Diners Club a payment intermediary between merchants and cardholders. Prior to Diners Club, almost all payments were made directly between merchants and customers through cash or proprietary bilateral credit agreements.

Following the success of the Diners Club, Bank of America (BofA) saw a huge opportunity to expand its credit business and gain access to a wider customer base and launched its first consumer credit card for the mass market. Bank of America mailed more than 2 million unsolicited, pre-approved credit cards to middle-class consumers that can 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 U.S. and even expanded to international markets, resulting in the first credit card payment network. But with that came huge operational challenges and serious credit risk, with the overdue rate soaring to over 20%. At the same time, along with rampant fraud, the entire project came to a near collapse.

People began to realize that the challenges and chaos within the banking network could only be resolved by establishing a truly cooperative organization that would formulate rules for managing systems and provide infrastructure. Members of the organization could compete on product pricing, but needed to adhere to unified standards. This organization later became what we know today as Visa. Another organization founded by California banks, which competed with Bank of America, later became Mastercard. This marked the birth of our modern global payment model, which has become the dominant structure in the global payment industry.

From the 1960s to the early 21st century, almost all innovations in the payment sector were centered around enhancing, supplementing, and digitizing the current global payment model. After the internet flourished in the 1990s, many innovations shifted to software development.

E-commerce was born in the early 1990s, with the purchase of Sting's CD on NetMarket being the first online payment. Subsequently, PizzaNet became the first national retailer to accept online payments. Well-known e-commerce companies such as Amazon, eBay, Rakuten, and Alibaba were established in the following years. The prosperity of e-commerce companies led to the emergence of many early independent payment gateway and processor companies. The most famous are Confinity and X.com, which were founded at the end of 1998 and the beginning of 1999, respectively, and they merged to become today's PayPal.

Digital payments have spawned many household names with hundreds of billions of dollars worth of companies. These companies connect offline merchants with online retail, including payment service providers (PSPs) and payment aggregators (PayFacs) such as Stripe, Adyen, Checkout.com, Square, and others. They solve merchant-side problems by bundling gateways, processing, reconciliation, fraud compliance tools, merchant accounts, and other value-added software and services. But it is clear that they are not disrupting the payment network of traditional finance.

Although some startups focus on disrupting traditional banking payment networks and card issuance infrastructure, well-known companies like Marqeta, Galileo, Lithic, and Synapse mainly aim to integrate new companies into existing banking networks and infrastructure, rather than disrupting existing payment networks. However, many companies find that simply adding a software layer on top of existing infrastructure does not lead to true explosive growth.

Some companies are well aware of the limitations of traditional payment methods and foresee that payment solutions can be built based on internet-native currencies that do not rely on traditional banking infrastructure, the most famous of which is PayPal. In the early 21st century, many startups focused on the development of digital wallets, peer-to-peer transactions, and alternative payment networks. By completely bypassing banks and card issuers, these companies give end customers a certain degree of monetary autonomy, including PayPal, Alipay, M-Pesa, Venmo, Wise, Airwallex, Affirm, and Klarna.

They initially focused on providing a better user experience, product portfolio, and cheaper transactions to groups that were overlooked by traditional finance, but gradually began to grab more and more market share. Sensing the threat of these alternative payment methods (APMs), traditional financial payment companies have since launched Visa Direct and Mastercard Send, which are also focused on providing real-time payment services for peer-to-peer transactions. While these models have been significantly improved, they are still plagued by the limitations of existing infrastructure. These companies still need to deposit funds or take on foreign exchange/credit risk, as well as hedge their own pools against each other, without the possibility of instant and transparent settlement.

The evolution path of modern payments is essentially: closed loop + trusted intermediaries → open loop + trusted intermediaries → open loop + partial individual autonomy. However, opacity and complexity still dominate, resulting in a poorer user experience and the presence of rent extraction at various stages throughout the network.

The Evolution of Merchant Payments

Businesses can bypass some or all of the traditional payment network's technical infrastructure using stablecoins. The diagram below is a simplified illustration of merchant payments:

and the responsibilities of each part in the stablecoin payment network:

Currently, Stripe is capable of handling a significant portion of the payment merchant side work, including providing merchant accounts and various software for operating businesses and accepting payments. However, they have not formed their own issuing organization or issued payment cards.

Now imagine a world where Stripe becomes the central bank, issuing its own stablecoin, backed by approved collateral by the GENIUS Act. Stablecoins enable atomic settlements between consumer and merchant accounts through a transparent open-source ledger (blockchain). You no longer need a payment card bank and an acquiring bank, Stripe (or any other issuer) only needs one (or several) bank to hold the collateral for its stablecoin issuance. They transact directly on the blockchain through their wallets, or by initiating a mint/redemption request to Stripe (issuer/central bank) and subsequently settle on the blockchain. The clearing and settlement of funds is done through a series of smart contracts that can handle refunds and disputes (see Circle's Refund Agreement). Similarly, the operation of payment routing or even exchange to other currencies/products can be achieved programmatically. Leveraging stablecoins and blockchain technology, bank-to-gateway, processor, and network data transfer standards become easier. With data transparency and fewer stakeholders, expenses and bookkeeping have become simpler.

In such a world, Stripe seems to have almost completely replaced the current payment model—possessing a complete infrastructure that provides accounts, card issuance, credit, payment services, and a network, all built on better technology, thereby reducing intermediaries and giving wallet holders almost complete control over the flow of funds.

Simon Taylor: "If you base everything on stablecoins, all transactions are just changes in numbers on a ledger. Merchants, gateways, PSPs, and banks previously needed to reconcile different ledger entries. With stablecoins, anyone operating with stablecoins is simultaneously a gateway, PSP, and acquiring bank; all transactions are just changes in numbers on a ledger."

This sounds like science fiction. Does reality have many issues related to fraud, compliance, the availability of stablecoins, liquidity / cost, etc.? Will there be incremental steps between today and this potential future? Just like real-time payment (RTP) technology, there will also be flaws; the programmability and interoperability of cross-border remittances are issues that RTP cannot solve.

The future is coming step by step, and some companies are preparing for it. Top issuers like Circle, Paxos, and withausd are expanding their products, while blockchain networks focused on payments such as Codex, Sphere, and PlasmaFDN are also moving closer to end consumers and businesses. Future payment networks will significantly reduce intermediaries, increase autonomy, enhance transparency, improve interoperability, and bring more value to customers.

Cross-border payment

B2B cross-border payments are one of the areas where the application of stablecoins has seen significant growth.

Matt Brown wrote an article about cross-border payments last year, and from this article, we can see that:

In many cases, there are multiple banks in the middle of cross-border transactions, all of which use SWIFT to deliver information, and SWIFT itself is not a problem, but there is an additional time cost associated with back-and-forth communication between banks, often involving other clearing counterparties. The fact that the liquidation process typically takes 7-14 days to complete is a huge risk and cost, and the process is extremely opaque. For example, it is not uncommon for JPMorgan Chase to "lose" millions of dollars for an extended period of time when transferring funds from a U.S. parent company to a foreign subsidiary. In addition to this, there is foreign exchange risk between multiple counterparties, resulting in a 6.6% increase in average transaction costs. In addition, when a company's capital flows across borders, it is almost impossible to earn interest.

So it's no surprise that Stripe recently announced the launch of stablecoin-based financial accounts. This enables businesses to access stablecoin-backed USD financial accounts, mint/redeem stablecoins directly through Bridge, and transfer funds to other wallet addresses through the Stripe dashboard. Use the Bridge API for fiat deposits and withdrawals, issue payment cards backed by stablecoin balances (depending on region, currently using Lead Bank), exchange for other currencies, and eventually convert directly to interest-bearing products for money management. While many of the current functions still rely on traditional systems as temporary solutions, stablecoins and tokenized assets do not rely on traditional systems for sending, receiving, issuance, and exchanging. Fiat deposit and withdrawal solutions are similar to the current state of alternative payment methods (APMs), with companies such as Wise and Airwallex essentially creating their own banking networks to deposit funds in different countries and net them at the end of the day. Airwallex's co-founder, Jack Zhang, rightly pointed this out last week, but he didn't consider how the world would change if fiat deposits and withdrawals were no longer required.

If you're just buying tokenized assets through stablecoins without converting them to fiat, you're basically bypassing the traditional correspondent bank model entirely. This will greatly reduce the user's reliance on a third party to actually hold and send the asset, allowing customers to capture more value and reduce the cost of payment for everyone. Startups such as Squads protocol, Rain cards, and Stablesea are all working on the possibility of buying and selling tokenized assets directly through stablecoins, and all companies operating in this space will eventually expand to the entire network.

However, if you want to convert stablecoins into fiat for use, Conduit Pay can directly collaborate with the largest foreign exchange banks in the local market to achieve seamless, low-cost, and almost instantaneous on-chain cross-border transactions. Wallets become accounts, tokenized assets become products, and blockchain becomes the network, significantly improving the user experience. If there is no need for fiat deposits and withdrawals, costs can be even lower. All of this can be achieved through better technology, providing simpler reconciliation, more autonomy, higher transparency, faster speeds, stronger interoperability, and even lower costs.

So what does all this mean?

This means that a payment-native world existing on-chain, based on stablecoins (digital changes on the ledger), is on the way. It will not only connect current payment models but will gradually replace them. This is why we will see the first trillion-dollar fintech company based on stablecoins soon.

I know this article will provoke many reasonable criticisms, such as my failure to consider certain issues. But please understand that I and many entrepreneurs who are starting businesses in this field have already recognized these problems and are working hard to address them. Innovation is like this; building incrementally on old systems will never truly lead to a brand new system, because vested interests will always obstruct the occurrence of this.

Closed loop + trusted intermediary → open loop + trusted intermediary → open loop + partial personal autonomy → a truly open digital native system where everyone can compete in the entire payment network and customers exercise autonomy through an open network.

This article only represents the author's subjective views and does not necessarily reflect the views of Dragonfly or its affiliated companies. Dragonfly may have invested in the companies mentioned in this article.