The traditional payment model is about to collapse, and the trillion-dollar stablecoin financial company is about to be born?

Author: Rob Hadick, Partner, Dragonfly

Compiled by: AididiaoJP, Foresight News

Stablecoins are not used to improve the improvement of existing payment networks, but to completely subvert the traditional payment networks. 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 digital changes in the ledger. At present, many emerging companies have begun to promote the reconstruction of capital flow methods.

Recently, many people have been discussing how stablecoins can become a bank-as-a-service (BaaS) network platform, that is, connecting existing payment channels, from issuing banks to merchant acceptance, and everything in between. Although I agree with these views, when I think about how companies and protocols can create and accumulate value in the future, viewing stablecoins as simply a platform connecting existing payment channels is actually an underestimation of its true potential. Stablecoin payment is a gradual improvement, representing the possibility of reimagining payment channels from the bottom.

To understand the direction of the future, we need to look back at history, because history reveals obvious paths 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, has launched its first multi-purpose accounting card. This accounting card introduces a closed-loop credit model, and Diners Club becomes a payment intermediary between merchants and cardholders. Before Diners Club, almost all payments were made directly between the merchant and the customer through cash or a proprietary bilateral credit agreement.

Following the success of Diners Club, Bank of America (BofA) saw a huge opportunity to expand its credit business and gain a wider customer base, and launched its first consumer credit card for the mass market. Bank of America has 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 U.S. banks and even expanded to international markets, resulting in the first credit card payment network. But what followed was huge operational challenges and caused serious credit risks, with the overdue rate soaring to more than 20%. At the same time, with rampant fraud, the entire project was almost collapsed.

People are beginning to realize that the challenges and confusion in the banking network can only be solved by the formation of a real cooperative organization that will develop rules for managing systems and provide infrastructure. Organization members can compete in product pricing, but they need to follow unified standards. This organization later became Visa as we know today. Another organization founded by Bank of California and competed with Bank of America later became Mastercard. This is the birth of our modern global payment model and has become the dominant structure of the global payment industry.

From the 1960s to the early 21st century, innovation in almost all payment areas revolves around enhancing, supplementing and digitizing the current global payment model. After the Internet flourished in the 1990s, many innovations moved to software development.

E-commerce was born in the early 1990s, and buying Sting's CD on NetMarket was the first online payment. PizzaNet then became the first national retailer to accept online payments. Well-known e-commerce companies such as Amazon, eBay, Lotte, and Alibaba have been established one after another in the following years. The boom of e-commerce companies has in turn given birth to many early independent payment gateways and processor companies. Most famous are Confinity and X.com, founded in late 1998 and early 1999, respectively, and after they merged to become PayPal today.

Digital payment has given birth to many household-known companies with a market value 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 problems by bundling gateways, processing, reconciliation, fraud compliance tools, merchant accounts and other value-added software and services. But obviously they have not made any disruptive changes to the payment network of traditional finance.

Although some startups focus on disrupting traditional bank payment networks and card issuing infrastructure, well-known companies like Marqeta, Galileo, Lithic and Synapse are primarily committed to introducing new companies into existing banking networks and infrastructure, and disrupting existing payment networks. However, many companies find that just adding a software layer to existing infrastructure does not achieve real explosive growth.

Some companies are well aware of the limitations of traditional payment methods and foresee that payment solutions that do not rely entirely on traditional bank infrastructure can be built through native Internet-based currencies, the most famous of which is PayPal. Many startups in the early 21st century focused on the research and development of digital wallets, peer-to-peer transactions and alternative payment networks. Completely bypassing the banking and card issuing alliances, giving end customers a certain degree of currency 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 deals to groups overlooked 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). Visa and Mastercard subsequently launched Visa Direct and Mastercard Send respectively, and also focused on providing real-time payment services for peer-to-peer transactions. Although these models have been significantly improved, they are still plagued by existing infrastructure constraints. These companies still need to deposit funds or assume foreign exchange/credit risks, and at the same time they need to hedge their own funds pools, and cannot 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 worse user experience and rent withdrawals are present in every link in the entire network.

The evolution of merchant payment

Businesses can bypass some or all of the traditional payment network's technical infrastructure with stablecoins. The following figure is a schematic diagram of simplifying merchant payment:

And the responsibilities of each part of the stablecoin payment network:

Currently, Stripe can handle a large part of the work of the payment merchant, even including providing merchant accounts and various software for operating business and accepting payments. But they did not form their own card issuing organizations or issue payment cards.

Now imagine a world where Stripe becomes a central bank, issuing its own stablecoins, and backed by the GENIUS Act by approved collateral. Stablecoins can achieve atomic settlement between consumer and merchant accounts through transparent open source ledger (blockchain). You no longer need a payment card bank and acquiring bank, Stripe (or any other issuer) just needs one (or several) bank to escrow the collateral of its stablecoin issuance. They trade directly on the blockchain through a wallet, or by initiating a minting/redemption request to Stripe (issuer/central bank) and then settle on the blockchain. The liquidation and settlement of funds are completed through a series of smart contracts that can handle refunds and disputes (see Circle’s refund agreement). Similarly, payment routing and even redemption to other currencies/products can be performed programmatically. With stablecoins and blockchain technology, it becomes easier to pass data standards from banks to gateways, processors and networks. Data transparency and stakeholder reductions, expenses and bookkeeping have also become easier.

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

Simon Taylor: "If you are based on stablecoins, all transactions are just digital changes in the ledger. Merchants, gateways, PSPs and banks need to reconcile different ledger entries. With stablecoins, anyone operating with stablecoins is the gateway, PSPs and acquiring banks, and all transactions are just digital changes in the ledger."

It sounds like science fiction. Are there many issues related to fraud, compliance, availability of stablecoins, liquidity/cost, etc.? Are there any gradual steps between today and this potential future? Technology like real-time payments (RTPs) will also have flaws. The programmability and interoperability of cross-border remittances are problems that RTP cannot solve.

Anyway, the future is coming step by step, 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. In the future, payment networks will significantly reduce intermediate links, and increase autonomy, increase 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 about cross-border payments last year, from which you can see:

In many cases, there are multiple banks in the middle of cross-border transactions, all of which use SWIFT to convey information. SWIFT itself is not a problem, but back and forth communication between banks creates additional time costs, which usually involves other liquidation counterparts. In fact, the liquidation 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 to "lose" millions of dollars for a long time during the process when transferring funds from its U.S. parent company to a foreign subsidiary. In addition, there is foreign exchange risk between multiple counterparties, resulting in an increase in the average transaction cost by 6.6%. In addition, when the company's funds are circulated across borders, they are almost unable to regain.

So it is no surprise that Stripe recently announced the launch of a stablecoin-based financial account. This allows businesses to access dollar financial accounts backed by stablecoins, mint/redemption stablecoins directly through Bridge, and transfer funds to other wallet addresses via the Stripe dashboard. Use the Bridge API for fiat currency deposits and withdrawals, issue payment cards backed by stablecoin balances (depending on the region, currently using Lead Bank), exchange for other currencies, and ultimately directly exchanged for interest-generating products for fund management. Although many of the current functions still rely on traditional systems as temporary solutions, the sending, receiving, issuing and exchanging stablecoins and tokenized assets do not rely on traditional systems. The fiat deposit and withdrawal solution is similar to the current alternative payment methods (APMs), such as Wise and Airwallex, which basically create their own banking networks, can deposit funds in different countries and make net settlements at the end of the day. Airwallex co-founder Jack Zhang pointed this out correctly last week, but he didn't think about how the world would change if fiat deposits and withdrawals were no longer needed.

If you just buy tokenized assets through stablecoins without having to exchange them for fiat currency, you basically completely bypass the traditional proxy banking model. This will greatly reduce users' dependence on the third party's actual holding and sending asset parties, 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 to realize 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.

But if you want to exchange stablecoins for fiat currency, Conduit Pay can work directly with the largest forex banks in the local market for seamless, cheap and almost instant cross-border transactions on-chain. Wallets become accounts, tokenized assets become products, and blockchain becomes network, thus significantly improving the user experience. If fiat currency deposits and withdrawals are not required, the cost can be lower. This can all be achieved through better technology and can provide simpler reconciliation, more autonomy, higher transparency, faster speed, stronger interoperability, and even lower costs.

So what does all this mean?

This means that a payment native world that exists on-chain, based on stablecoins (digital changes in the ledger) is coming. It will not only connect to the current payment model, but it will also gradually replace it. That's why we'll see the first trillion-dollar scale fintech company based on stablecoins coming soon.

I know this article will cause a lot of reasonable criticism, such as I didn't consider certain issues. But please understand that I and many entrepreneurs who start businesses in this field have become aware of these issues and are working to solve them. Innovation is like this, and progressively building on old systems never really brings a whole new system, because vested interests always block all of this.

Closed loop + Trusted intermediary → Open loop + Trusted intermediary → Open loop + Some individual autonomy → A truly open digital native system, everyone can compete in the entire payment network, and customers exercise their autonomy through the open network.

This article represents only the author's subjective view and is not necessarily the view of Dragonfly or its affiliates. Dragonfly may have invested in the