The combined whopping US$40 billion revenue earned by Visa and Mastercard in 2021 actually reflects an inefficiency in the current payment systems that unfortunately falls on the shoulders of merchants. The broader theme of web 3.0 is about getting rid of intermediaries — Payments is one immediate sector that has a lot to benefit from it. It’s difficult to build payment tools and products on top of legacy blockchain such as Bitcoin or Ethereum because of scalability issues such as high gas fees and long transaction times.
This was until we found out about Solana Pay — a payments rail built entirely on the Solana network. Read on to find out why we believe that it will be a long-awaited tipping point for the payment sector.
Problems with traditional payment systems
In order to understand how Solana Pay seeks to disrupt the traditional payment sector, it is pertinent to take a look at the various pain points in the current system. The Covid-19 pandemic has accelerated the use of digital and contactless payments which often involves the use of credit/debit cards. As such, the current retail payment system is loaded with intermediaries that result in a typical processing fee ranging from about 1.3% to 3.5% for merchants. Although this figure seems small, but it can quicky add up with recurring payments and larger volumes.
The diagram above highlights how payment flows through various intermediaries before reaching the merchant. The primary fees that merchants have to face are (1) interchange, (2) assessments, (3) acquirer fees and (4) payment processing fees.
Interchange occupies the bulk of card processing fees. Interchange is the fee charged by the issuing bank (e.g. Citi, Bank of America) for settling a transaction. Interchange fees usually consist of a percentage of each transaction along with a flat charge (e.g. 2.1% + $0.10). Assessment fees are paid to card networks (e.g. Visa & Mastercard ) for being the intermediary between the acquiring and issuing banks. Acquirer fees are paid to the acquiring bank (e.g. Chase, Wells Fargo) for underwriting risk and also for paying out to the merchants. Payment processing fees are paid to the providers (e.g. Stripe, Square) that provide the payment software or hardware to the merchant. Furthermore, the payout is not instantaneous as merchants would usually have to wait for a few days before they receive the payout.
The image above shows the various stakeholders in the global retail payment network that stands between the consumer and the merchant.
Additionally, there are privacy and security risks that comes with the use of card payments. Cards are connected to sensitive information such as social security number, address, transaction history etc. The flow of information across the various stakeholders results in risk of leakage at any point in time. Illegal or fraudulent transactions can also take place on behalf of consumers especially with the increasing use of contactless cards and transactions that do not require signatures.
Early promise of blockchain disrupting payment landscape
The emergence of blockchain showed early promise in disrupting the traditional payment landscape. Blockchain technology had potential to facilitate fast, secure, low-cost payment processing services (and other transactions) through the use of encrypted distributed ledgers that provide trusted real-time verification of transactions without the need for intermediaries such as banks and other institutions.
The famous story of how first commercial Bitcoin transaction took place — when Florida man Laszlo paid for two Papa John’s pizzas with 10,000 Bitcoins, showed how payment can be decentralized without the involvement of all the intermediaries.
Problems with early crypto payment systems
However, in reality there were several factors that drove weak acceptance of cryptocurrency for retail payments. Firstly, the transaction speed of cryptocurrencies like Bitcoin and Ethereum were lacking compared to incumbents Visa and PayPal. Payments processed on networks such as Ethereum might require an uncertain amount of time ranging from 10–30 minutes which is unacceptable for merchants looking for on-the-spot transactions. In ecommerce and online purchases, the longer it takes for payment to process, the higher the chance of abandoned carts. The low TPS and heavily congested networks of most popular blockchains have also resulted in high transaction fees which the consumers might be unwilling to pay for. For instance, the average transaction cost on Ethereum in 2022 is around $42 which probably exceeds the cost of most small ticket items.
Secondly, merchants are unwilling to settle in volatile crypto payments — most merchants would prefer to settle with fiat currencies. Merchants are worried that the volatility of cryptocurrencies might eat into their profit margins and cause a lot of uncertainty on their income. As such, existing efforts to integrate crypto payments would often include the element of off-ramping. For instance, Crypto.com and Visa partnered up together to allow consumers to spend their cryptocurrencies on their exchange wallet. When a transaction goes through, the crypto funds will be converted to fiat by Crypto.com before it proceeds through the Visa network. Such a system involves extracting fees from both consumers and merchants through crypto-to-fiat exchange fees and via the usual credit card intermediaries.
From a consumer standpoint, there also needs to be a mobile-first digital wallet that allows consumer to send payments easily and securely. While P2P transfer of funds is fairly common, there is still friction around mobile retail payments. Furthermore, crypto wallets can be a daunting hurdle for new users and there needs to be a simple and easy UX in a similar vein to most web2 payment apps
The recent launch of Solana Pay has reignited the conversation around crypto payments and we believe that Solana Pay will a game-changer for the various reasons outline below.
Solana Pay was announced in February 2022 and it is a new blockchain based merchant payment system enabling decentralization and control of data to businesses and consumers by cutting out intermediaries. Crucially, Solana Pay works with Circle’s USDC or any other Solana-compatible stablecoin. This is important because stablecoins are able to combat the prior problem of volatility. Receiving USDC is akin to receiving US dollars as the value will always be pegged to the fiat currency. A stablecoin would be effective as a store of value and a medium of exchange for merchants, just like a fiat currency, while retaining the decentralized aspects of a cryptocurrency. For merchants, there is little downside in cutting out the middlemen as they have better margins from transactions and they do not have to face any crypto volatility in prices.
“The transfer of assets between consumer and merchant should be instantaneous like sending an email” — Sheraz Shere, Head of Payments of Solana Labs
By implementing the payment rails on Solana, the prior problem of slow and expensive transactions can also be rectified. Solana is known as the potential “Visa of the digital asset ecosystem” because of its potential blazingly fast speed of 65,000 TPS. While it is currently averaging around 2000 TPS, it is still significantly higher than the other existing blockchains. Additionally, the average cost of a transaction on the Solana network is only $0.00025 which is significantly lower than the incumbents.
Solana Pay offers a similar user experience to most contactless payment methods such as Apple Pay and Samsung Pay. Consumers are able to simply scan a QR code to complete their transaction physically or virtually. Another major difference is that merchants are able to receive the funds immediately instead of currently waiting for 3 business days. This is a groundbreaking development because the flow of funds has never been this efficient and thus merchants are able to improve their working capital. Essentially, payment is just an asset transfer between the consumer and the merchant — it should be simple and instantaneous but the state of the current payment infrastructure simply does not allow it.
We believe Solana Pay is not just about payments. At its core — it should be simplifying the communication between merchants and their consumers. With Solana Pay, merchants are also to send digital assets such as NFT back to the consumers as loyalty rewards which will open up new capabilities in commerce not possible before. The is not just beneficial for merchants but for consumers as well. With this value proposition, Solana Pay might be able to incentivize the next million businesses and consumers to adopt Web3.
Imagine you just bought a sneaker at a store using Solana Pay, you also receive a matching NFT in the same transaction which is exclusive to you and a smart contract enabled discount offer that is applicable to future purchases. Merchants can also pass on their transaction cost savings to customers by offering them discounts on their purchase if they pay with Solana. In turn, more consumers will be incentivized to pay with crypto. Once the flywheel of attracting more merchants and consumers into crypto payments starts with Solana Pay, it will change the landscape forever as this direct communication channel between the merchants and consumers opens up new possibilities for future innovations.
Solana Pay’s Ecosystem
“This is about giving third parties the tools to build the end consumer solutions.” — Sheraz Shere, Head of Payments of Solana Labs
The beauty of Solana Pay lies in the fact that it is open source and it allows applications to be built on top of it. For example, mtnPay have leveraged Solana Pay and Square to create a POS integration — all the merchants need is an iPad, a Square account and a Solana Wallet. Solpay.store is a merchant payment solution that can be easily and quickly integrated into any Wordpress site as an alternative payments gateway. PocketPay is a Solana chain-based merchant wallet compatible with Solana Pay. Autonomous.ai built a smart contract payment stack with Solana Pay. Solana Pay is constantly encouraging more innovation and addition to their ecosystem by recruiting developers and organizing hackathons.
It is still a massive undertaking to disrupt the current payment landscape. Operators like Visa, Square and Stripe have built a substantial moat that it will be difficult to convince merchants even though with Solana Pay’s obvious benefits. For instance, Stripe has achieved a massive vertical integration between their products that merchants have been deeply entrenched in. Besides payments, Stripe offers other products such as fraud detection, billing, invoicing, taxes, treasury services etc. for their merchants. This is precisely why Solana Pay’s focus on building their ecosystem matters.
While it is still early days for crypto payments in the retail space, we believe that the increasing adoption of crypto, emergence of stablecoins along with the Solana Pay infrastructure could be the tipping point that triggers a disruption of the status quo.
Disclaimer: The information and publication are not intended to be and do not constitute financial advice, investment advice.