Payments are one of the most promising areas for blockchain technology. But I believe they are not always well understood, and the discussion sometimes gets confused and overly ambitious.
Blockchains could face an uphill battle to replace traditional payment systems even though they look relatively competitive at the moment. On the other hand, I think many people are ignoring the biggest opportunity areas because they are not looking at the true transaction costs.
Paul Brody is EY’s global blockchain leader and a CoinDesk columnist.
One enduring myth is that old technologies, like mainframes, are driving up the cost of payments. In fact, centralized payment systems are extremely efficient. Indeed, it seems unlikely that decentralized systems will ever be more efficient as they involve lots of copying of data and verification. Decentralized systems are getting more efficient at this, but they are chasing a moving target.
Centralized systems are not sitting still, but they typically offer somewhat limited functionality. It is usually about transferring money and often involves little in the way of complex business logic support. Centralized systems work very well when the payment is one directional. Point-of-sale systems, person-to-person payments and repeated long-term payments, like payroll or mortgages, work very well in these contexts.
The real drivers of high costs in traditional payments are often either complex regulatory requirements or a lack of competition. This can lead people to confuse cost and price or to make what is, in effect, not really an apples-to-apples comparison.
Comparing a highly regulated system to one that sits in a gray area can be misleading. Many crypto-based remittance applications do little or no know-your-customer and anti-money laundering checks, which are costly and difficult to run. This is a cost advantage that is unlikely to last.
Low levels of competition are another big driver in high payment costs. This is true both for business-to-business and consumer-to-consumer payments. There are only a few big global payment networks, though competition in this space is rising. On the consumer side, the big driver of costs are retail networks.
Payments between consumers who already have smartphones and bank accounts are relatively low cost, but the costliest payments are ones that take place between people who do not have bank accounts. These depend on physical retail networks that accept cash, and only a few companies have built those.
Low levels of competition represent a big opportunity for crypto payment firms to enter markets with higher functionality and lower prices. I personally believe that the consumer side is the toughest because the highest prices are well defended by retail networks that took many years to build. However, on the more competitive side, specialized networks like Lightning for bitcoin can level the field. They might not be as fully decentralized as the main network, but they represent very low costs and speed. Similar layer 2s that specialize in low-cost transactions are taking shape in the Ethereum ecosystem as well.
On the business side
On the business side, blockchains can drive costs down and build sustainable advantage through differentiated technology. While it is true that main-net transaction costs in Ethereum are higher, the addition of smart contract functionality changes the equation entirely.
Enterprises issue payments to each other usually as part of a complex agreement. This usually means not only verifying receipt of goods or services, but also compliance with the agreed upon terms. The American Productivity and Quality Center (APQC) estimates that it costs about $100 on average for a large company to run this process. That cost is mostly human labor.
In this context, the actual payment cost is <10% of the total and the other 90% is addressable using smart contracts.
Smart contracts automate the process of checking with compliance terms and conditions and the result is faster execution at a fraction of the cost. While the actual payment, being executed on-chain, may be technically be somewhat higher, the total cost of running the business process is much lower. Real world experience at EY shows a 40% cost reduction, and we expect that to go even deeper as our skills in this space improve.
The biggest obstacles to making this process work on-chain has been the lack of built-in privacy and data integration from enterprise systems. Smart contracts and payments without privacy disclose too much sensitive data for most enterprises to be interested. Now that these issues are addressable using Zero Knowledge proofs (ZKPs) and circuits, the path is clearer. It will still require companies to link the enterprise systems to on-chain smart contracts, but this is a more straight-forward requirement to implement in most cases.
Right now, the kind of fully digital end-to-end systems that smart contracts enable are the province of the world’s biggest companies. With scale and deep pockets, big companies have built integrated systems without blockchains. However, because they are highly customized and built on private systems, they are too costly and complex for most smaller firms to manage. As blockchain access spreads through the business world, we will see more than just efficiency, we will see a more level playing field between small firms and large enterprises.
