Before we jump into this deep-dive, I want to share an update about the newsletter.
In March 2022, I decided to quit my job to launch something of my own. I decided to explore without constraints and as you know, most of my time has been spent on Web3. Whilst I remain bullish about web3 and the prospects of crypto, I’m expanding the scope of the newsletter to tech more broadly.
I’ve always been a problems first, solutions second type of person and I’d like the newsletter to reflect this. I’ll aim to cover problems that technology can address, with crypto being one of those things. Let’s get into it.
Payments is frequently stated as one of the big use cases for crypto. It’s exciting because crypto settles instantly (most of the time), it is borderless, and transaction costs are low (with caveats). Despite all of this, crypto is not a great solution for payments, barring a few exceptions. Read on to see why and what needs to happen for this to change.
Lifecycle of crypto
We’ll start by looking at the lifecycle of crypto: acquiring it, sending it and selling it.
Acquiring crypto, commonly called on-ramping, is expensive.
Today, you can acquire crypto using an exchange like Coinbase or using tools like Moonpay (facilitates crypto payments). OnRamper compares different onboarding options and gives you the best rate. At the time of writing, a user will receive 95.5 cents for every dollar if they bought a stable coin like USDC.
The key takeaway:
On ramping is expensive and costs at least 4%.
Instant settlement and transaction costs depend on the blockchain being used and the demand on the network at any given time. At the time of writing this, Ethereum costs 0.42% and Solana costs 0.034%. For the rest of this deep-dive, we’ll assume we’re on the Solana network. This can mean using Solana today, or that the cost of using a bigger chain like Ethereum will come down over time.
Sending Ethereum costs 0.42%
Sending Solana costs 0.034%
Sending crypto costs 0.034%
Selling crypto (called off-ramping) is not as expensive. As of writing this deep-dive, It costs 42 cents to convert USDC into USD.
The key takeaway:
Off-ramping costs at least 0.42%.
Crypto vs. fiat unit economics
If you’re using crypto rails as a business, here’s how you can facilitate the transfer of money:
- User buys crypto
- Crypto is sent to the company’s wallet
- Crypto is exchanged for fiat
At a minimum, this costs 4% (acquire) + 0.034% (transfer) + 0.42% (sell) = 4.54%. In addition, there’s a FOREX fee involved to convert US dollars to the local currency (most stable coins are denominated in USD today).
If an online shop uses fiat, customers are likely to pay with a debt or credit card. The process is fairly complicated (see this link for a breakdown). Generally speaking a merchant would pay between 2% - 4%.
Crypto isn’t cheaper than the traditional financial system yet.
Beyond the unit economics
In my view, the economics will improve over time — it usually does with technology. The real question is whether it will beat the traditional route.
Consider stable economies like the US, India or the UK, goods and services are denominated in local currencies, not in crypto. For crypto to become a medium of exchange, you need to be able to buy stuff with it.
For you to buy stuff with it, merchants need to have an incentive to offer crypto payments. Frankly, merchants do have these incentives. They get paid faster. They don’t have to deal with customers disputing transactions (chargebacks). Cross-border payments are a walk in the park.
But the problem isn’t merchants, it is customers. Customers don’t have an incentive to spend with crypto. Today, merchants are absorbing the cost of fees for your debit and credit card payments. Crypto flips this and asks customers to pay instead.
In addition, customers have to forgo benefits they receive today. First, most customers earn rewards or cash back on their debit and credit cards. Second, chargebacks - which merchants hate - serve as insurance for customers. If someone steals your credit or debit card, you can call your bank and ask them to block a transaction. Neither of these are possible with crypto today.
The other interesting dynamic is crypto’s use case as an asset class. Every person who loves crypto believes the price of cryptocurrency like BTC or ETH will go up over a long-enough time horizon. If you have $100 in your wallet as USDC, the opportunity cost of spending it is higher than the opportunity cost of investing it. This is because the cost of converting USDC to Ethereum is much cheaper than the cost of buying Ethereum with fiat.
When it works
There are exceptions to the rule.
Crypto is a great medium of exchange when the currency of a country is failing. Take the Turkish Lira or the Argentinian Peso. These currencies have lost tremendous value against the US dollar. Their citizens are turning to crypto to protect their assets. Holding your wealth in BTC or ETH is a better bet because it doesn’t depreciate in value (relative to the local currency).
Crypto native goods
Crypto is a great medium of exchange for crypto native goods like NFTs. This is because these goods are denominated in cryptocurrency and require crypto.
All of the above represents the situation as it stands today. Here’s how it might change:
- People get paid in crypto. As a result, they circumvent the onboarding costs and it becomes a lot cheaper to send money cross-border or pay with crypto.
- Acquiring crypto becomes much cheaper. This is tough, but not impossible. It’s expensive today because — despite crypto’s desire to circumvent the traditional financial system — it very much relies on it. When you buy crypto, you do so using a bank transfer or a credit or debit card. The company facilitating this transfer between fiat and crypto is always going to want to make a cut.
- Goods and services start being denominated in crypto. As noted above, the problem here lies with customers, not merchants. There needs to be some incentive for customers to spend crypto.
If you’re building in crypto today, I urge you to do one of two things. First, you can go after the use cases that do not involve crypto as a medium of exchange (for the reasons noted above). There’s lots of interesting stuff in the decentralised finance space (targeting crypto as an asset class), creator economy (helping creators own their audience) or the metaverse (whatever that means).
Second, you can be bold and try to bring down the cost of onboarding into crypto. This is a big market but a difficult problem to solve. Typically, the people who move the most money have the biggest leverage with exchange rates. It’s worth asking how you’ll be able to beat the exchange rates that the Coinbase’s and Binance’s of this world can offer.