Throughout time, payments have been an integral component of human civilization. Payment systems have undergone multiple transformations from the early days of barter to the current age of digital payments. Prior to 1200 BC, livestock, grain, and cowry shells were used as currency. Of course, the barter system could only operate in primitive societies.
The creation of ‘commodity money’ followed the barter system. The foundation of ‘commodity money’ is that the commodity itself has intrinsic value. The most well-known form of commodity money is gold, which has played a significant role in the international monetary system. Gold coins were first struck on the order of King Croesus of Lydia around 550 BC and they circulated as currency in many countries before the introduction of paper money. Paper money backed by precious metals followed commodity money. Ultimately, the world shifted to the use of government-issued fiat currency.
Over the last few decades, we have witnessed enormous improvements in payment systems. Credit and debit cards allow for quick checkout. Consumers enjoy protection for fraudulent transactions and are rewarded with loyalty points for purchases. Mobile payments are now a major disruptor. Some indicators reveal that in the near future, the majority of payment transactions will originate on handheld devices.
Enter the age of cryptocurrencies. A cryptocurrency is a medium of exchange that represents money in digital form without any physical component. By far, the most well-known cryptocurrency is bitcoin. Some of the most notable features of bitcoin are high transparency, no intermediaries, low transaction fees, speed, and the non-repudiable nature of transactions. Unlike government-issued currencies, which are created by monetary policy and fractional reserve banking, cryptocurrencies are created in a predictable manner through a process called ‘mining’. The bitcoin network is not controlled by any single central authority, but instead works on a consensus of miners who write the shared ledger, which is called the ‘blockchain’.
The current system we use for managing assets and currency exchange dates back to the time of the Florentine Renaissance. Since then, central monetary institutions have intermediated all transactions. Up until the invention of Cryptocurrency, we have not known any other system. Cryptocurrency allows individuals to exchange value securely without an intermediary. The impact of the cryptocurrency system is highly significant in several application areas: e-commerce, peer-to-peer payments, and cross border commerce and payments.
The majority of e-commerce transactions that take place today use credit cards as a payment method. These cards were designed for physical use at the point of sale, where the card is ‘read’ by a terminal. The cardholder is authenticated by methods such as a wet ink signature on a printed receipt, a signature captured on a touch sensitive POS screen, or a secret PIN number. Such cards have been adapted since the birth of e-commerce by merchants and processors for use on the Internet. Fraud and non-repudiation with credit cards is a serious issue due to the weak authentication and inherently insecure mechanics. Other issues include delayed settlement, high cost of acceptance and chargebacks. Bitcoin offers a solution through its non-repudiable instant payment with no chargeback risk for merchants and hence will be a major disrupter for online payments.
The casual electronic peer-to-peer payment space is currently exploding with multiple vendors offering competing solutions. The canonical solution is to draw payee funds from a payment instrument such as an ACH account or debit card and use it as a ‘stored value’ to disburse to payees. Payees have the option to transfer their stored value to a bank account or to use it for other payment activity. These peer-to-peer solutions have multiple hand off points with various intermediaries. On the contrary, Bitcoin offers a trustless, borderless, and instant payment mechanism that has the potential to disrupt this space.
Cross border remittances involve correspondence banks with Nostro and Vostro accounts. Included in such systems are pain points of high fees, forex risks, as well as the lack of transparency on the status of payments. Bitcoin offers instant cross border payments and hence eliminates all of the prior pain points in payments.
Overall, cryptocurrencies are innovations that hold far reaching consequences for the payments industry. There is limited technical debt in the platform for large scale adoption. Several applications in the payments industry will be disrupted during this revolution, ultimately resulting in unimaginable benefits for users of the technology.